IRC 7872 is a provision in the U.S. tax code that addresses below-market loans, including those made within families. Let’s break down how it affects family loans:
Gift Loans and Demand Loans:
If a family member provides a below-market loan (one with an interest rate below the prescribed market rate), the forgone interest (the difference between the market rate and the actual rate) is treated as follows:
The lender is considered to have transferred (gifted) the forgone interest to the borrower (may require filing gift tax return if the interest is high enough).
The borrower is then deemed to have retransferred the same amount back to the lender as interest (again a gift tax return may be required and the lnder has interest income even though they receive no cash) .
This ensures that the lender doesn’t give away the use of their money without tax consequences1.
Other Below-Market Loans:
For loans that don’t fall under the gift or demand loan category, the rules are slightly different.
The lender is treated as having transferred cash to the borrower equal to the excess of the loan amount over the present value of all required payments under the loan terms.
Such loans are considered to have original issue discount (OID) equal to this excess amount.
OID is additional to any other original issue discount on the loan1.
Applicability:
IRC 7872 applies to various types of below-market loans, including:
Gift loans
Compensation-related loans between employers and employees or independent contractors and service recipients
Corporation-shareholder loans
Tax avoidance loans (where the interest arrangements aim to avoid federal tax)
Other below-market loans as defined by regulations1.
Minimum Interest Requirement:
To prevent tax avoidance, IRC 7872 requires that loans between related parties (including family members) bear a minimum amount of interest based on applicable federal rates (AFRs).
This rule applies to loans usually exceeding $10,000.
In summary, if you’re providing a family loan without interest, be aware of the IRC 7872 rules to ensure compliance with tax regulations. Always consult a tax professional for specific advice related to your situation
if you make it a gift, there may be the need to file a gift tax return. as a true gift there would be no interest to report. A "gift" is not a "gift" if it is repaid if the "gift" was repaid the IRS would likely view the gift as a sham transaction which can have severe adverse tax consequences for both parties.
not knowing your particular circumstances consult with a tax pro.
