Here is some information about how you can help a family member buy a home by giving them a loan. Both you and the family member will benefit from a loan structure that is good for taxes.
With the national average interest rates for 30-year fixed-rate mortgages at 6.81 percent and for 15-year fixed-rate mortgages at 6.13 percent, family loans can be a much better option. By charging the borrower the applicable federal rate (AFR) as interest, you can give them a good deal without giving yourself a tax headache.
Every month, the IRS sends out new AFRs for term loans. Here are the most recent prices recorded in April 2023:
• Short-term loan (less than three years): 4.86%
• A loan with a term between three and nine years: 4.15 percent
• Loans with terms of nine years or more: 4.02 percent
If you charge a family member at least the AFR for a term loan, you can avoid problems with federal income tax and federal gift tax.
But if you charge less than the AFR, you may have some tax issues to deal with. The $10,000 and $100,000 “loopholes” in the tax law can help you avoid these problems, but they may not be right for all home loans.
For the borrower to be able to claim deductions for qualified home interest expenses, the loan must be written down in a promissory note and be backed up by the home. Make sure the borrower signs the note and that the note has details like the interest rate, a schedule of interest and principal payments, and any security or collateral for the loan.
In the end, homebuyers can get better interest rates on family loans than from commercial lenders, especially if a family member is the AFR. When setting up the loan, don’t forget to think about the terms and the tax effects.
We know that taxes can be hard. Schedule your free tax consultation and find out more about how the ideas in the article can apply to your specific tax situation.