Giver of a gift loan needs tax advice


January 09, 2000

Dear Mr. Azrael:

I intend to make a $30,000 "no-interest" loan to my daughter and son-in-law so they can pay off a mortgage on their townhouse. How will the IRS treat a no-interest loan?

Jean Cohen


Dear Ms. Cohen:

As a general rule, a no-interest loan is considered to be a gift loan, where you are forgiving the interest that normally would be paid by the borrower.

The IRS refers to this interest as "foregone interest."

The foregone interest for any period equals the amount of interest that would be payable if interest accrued on the loan at the applicable federal rate and was payable on Dec. 31.

Simply, the IRS would hold you responsible for the interest that you would normally have collected. You would have to declare that interest even though the interest was never paid.

On the other hand, your daughter and son-in-law may be able to take the interest deduction if the gift loan is secured by a mortgage on the townhouse.

The gift loan rule does not apply to loans of $10,000 or less between individuals if the gift loan is not directly used to buy or hold income-producing assets. Also, if the loan is repaid within the calendar year that it is made, an exemption by the IRS may apply.

You should consult your tax adviser or accountant to structure the gift loan in a way that will minimize income tax.

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