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Lending Money to a Family Member

 

 

Lending Money to a Family Member

Sometime in your life you may be asked to lend money to a family member – offspring or sibling. There are a few issues to consider. First, can you afford to loan the money and not get it back? Presumably whoever is borrowing the money could not get it elsewhere. If they have tried a bank and were turned down, perhaps the bank has a keener eye for success than you which suggests lending might not be a profitable idea and you may not get your money back.

But banks have been wrong before and you may wish to take a chance anyway. Now comes the issue of interest – what rate will you charge.

As long as the loan is for $10,000 or less, there won't be a problem. However, if the borrowed amount is larger and you do not charge the going rate of interest, the IRS will "impute" interest for you, based on its own assumptions. You'll end up being treated as if you had charged/earned interest, even though you hadn't, and you'll owe tax on that "phantom income" that you didn't receive.

If lending to an offspring, special rules may apply. If the loan is for $100,000 or less, the interest you will be considered to have received annually for tax purposes is limited to the amount of your child's net investment income for the year. And if that amount doesn't exceed $1,000, you can avoid taxable interest income on the intra-family loan. But the IRS may still intercede if it suspects that you're trying to dodge the tax liability.

How do you figure out what the "going rate" for interest is? It depends on several factors, including the type of loan, its length, and the interest rates in your local area. You might be able to charge slightly less than a local bank, but you can't go overboard.

What happens if you do not get paid back? The IRS could determine that the "loan" was always meant to be a gift. To avoid that problem, it's best to have an attorney draft a formal loan document. It should include the usual terms that would be found in a bank loan. For instance, the document will usually indicate:

·         The amount of the loan;

·         The time allowed for repayment;

·         The interest rate structure;

·         A description of the collateral securing the loan.

Finally, have the loan document witnessed and notarized. This is the best proof you can have if the IRS ever challenges the deal. Also, keep records showing repayments to demonstrate that the arrangement is a bona fide loan.

This article was written by Steven Erickson based upon material prepared by a professional financial journalist for Erickson Financial Solutions, LLC and is not intended as legal or investment advice.

 

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