Family Loans and the Gift Tax
What you need to know…
Family Loans and the Gift Tax. Monetary gifts to friends and family members made can be up to $17,000 per year (2023) without any issues on Taxes. There are two ways to handle gifts over the “free” limit. One is that you file a gift tax return and the other method is to loan the money to your family in a proper manner. Any amount over the $17,000 per year must be handled by documenting the amount as a loan to avoid Filing IRS Gift Tax Returns.
“Gift Loans.” It is important for you to properly document the loan in writing.
What’s the most common problem that individuals make? It is that they do not document the Family Loans and the Gift Taxes 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 in your File for the IRS. If you are going to ask for an interest, you have to document terms of payment and the collateral involved in the loan just to have everything in black and white.
Likewise, if you will not do this properly, you may find yourself paying gift Taxes on the loan. The good thing about documenting these loans is that you do not have to use a lawyer for it unless the loan is for a mortgage. You just need to write it on your own, this document is calls a “note”.
Family Loans: The Note
Once you have the note, it is important for you to keep it safe. 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 the loan to be acknowledged in writing is to get the benefit for Income Taxes on mortgage interest.
This note will also make it very clear to you, the borrower and the IRS that the money obtained from you is a loan and not as a gift. So this is a clear 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 force you to use their nominal rate. 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. Yes, Taxes are always involved.
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 Taxes 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 $16,000 aside for those larger loans. With this management, you can maximize the amount of total free gifts and save on possible Taxes. Just imagine all the things that you can do if you use the “demand Loan” properly. If you are going to “gift” money to someone, there is no reason to pay Taxes on it too. Setting up the proper structure is important to limit your Taxes. There are various ways to limit your Taxes. You can use a demand loan and use your lifetime benefits of gift Taxes.
If you Gift (2023) $17,000 or less per year to someone it is a “free” transaction on your income tax Returns. But if you gift more than $17,000 (2023) to any one person in a year, you MUST either File a Gift Return for Taxes OR properly document it as a loan with a proper Note. You would just need to be compliant with the Federal interest rates set. We would recommend that you check with an accountant or a tax lawyer, BEFORE you get yourself into trouble. These rates can be found on the IRS’ web page. Still, if you have any questions, please feel free to ask.