Family Loans and the Gift Tax
Monetary Gifts and Loans
Family Loans and the Gift Tax. Monetary gifts to friends and family members made can be up to $15,000 per year without any issues. Any amount over the $15,000 per year must be handled by documenting the amount as a loan to avoid filing a gift tax return.
It is important for you to properly document the loan in writing.
The most common problem that individuals make is that they do not document the Family Loans and the Gift Tax especially if they are not going to ask interest for it. The truth is that even if you are not going to ask for an interest rate, you still have to document it. If you are going to ask for an interest, you have to document terms of payment and the collaterals involved in the loan just to have everything in black and white. If you will not do this properly, you may find yourself paying a gift tax on the loan. The good thing about documenting these loans is that you do not have to use a lawyer for it. You just need to write it on your own, this document is calls a “note”.
Once you have the note, it is important for you to keep it with you especially if the money loaned from you is going to be for mortgage or purchasing a property. Most of the time, these loans that are used for mortgages will usually undergo legalization through a title company or a lawyer. The reason why it is important for this loan to be noted is to get the tax benefit to be given for mortgage interests.
This note will also make it very clear to you that the money obtained from you is a loan and not as a gift. This is just a way of establishing financial obligation to the borrower.
Most of the time, people who are loaning money to their relatives would usually not ask for an interest. However, if you don’t provide an interest amount in the note, the IRS may put it on. This is what you call imputed interest. The definition of a loan is that it should have interest rate and that interest is taxable by the IRS.
Using a Demand Loan to your benefit
Within the note, the time period of the loan is required. Using a Demand Loan means that you can demand for the amount to be paid in full whenever you want. But you can just use this for formality with the IRS in terms of computing the imputed gift. Both you and your borrower can still arrange the payment schedule and options informally.
Imputed gift will be determined on an annual basis on the demand loan. Within a year, the interest needed to be paid in a year will be given a total amount of $15,000 aside for those larger loans. With this, you can limit the total free gift tax that you consume to only $15,000 yearly. Just imagine all the things that you can to consume if you will not have a demand loan like tax exemption on estates and lifetime gift tax benefits.
If you Gift $15,000 or less per year to someone it is a “free” transaction. But if you gift more than $15,000 to any one person in a year, you MUST either file a Gift tax return or properly document it as a loan with a proper Note. You would just need to be compliant with the federal rates set that can be found on the IRS’ web page.