Family Loan: Is interest taxable if the interest amount is gifted?

[MarkFrost]

Hello Team,

Assumption:  The year is 2023 and the annual gift exclusion is $17,000. My father loans me money and the total interest in 2023 is $17,000.  My father gifts me the $17,000, therefore I do not pay it.

Question:  Is the interest of $17,000 taxable income for my father?

Thank you very much,

Mark

[Opus 17]

Yes.  (I could go into a complicated discussion of the imputed interest rules, if you like, but the bottom line is that your father must report the interest as taxable income, even if he forgives or "gives back" the interest.)

[MarkFrost]

Thank you for your response.  Does imputed interest apply if the interest is calculated at an AFR?  The amount of interest is appropriate, but the interest is not collected in cash, it is gifted.

[Opus 17]

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@MarkFrost wrote:

Thank you for your response.  Does imputed interest apply if the interest is calculated at an AFR?  The amount of interest is appropriate, but the interest is not collected in cash, it is gifted.

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Right.  The IRS expects taxpayers to conduct their affairs in a businesslike manner, and that includes charging interest on loans.  The lender must report as taxable income, the interest they collected or could have collected if they charged at least the AFR, even if they did not actually collect the interest.

If you said the parent collected the interest and then gifted it back, the collected interest is taxable income to the parent.  If you said the interest was forgiven and never collected, the parent must still report interest income equal to the interest they would have collected if they charged at least the AFR. 

[tagteam]

@MarkFrost 

You should also be aware that if you and your father do not have some sort of written agreement for repayment, including some form of amortization schedule, the IRS could recharacterize this entire "family loan" as a gift. 

[Mike9241]

probably subject to IRC code section 7872 which would require him to recognize the interest. you may want to confer with a tax pro

[Deborah26]

If the annual interest was not forgiven but was gifted to the related party, is the lender still required to report the interest as income on the loan?

[Opus 17]

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@Deborah26 wrote:

If the annual interest was not forgiven but was gifted to the related party, is the lender still required to report the interest as income on the loan?

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If it is a legitimate bona fide loan, with the expectation of being paid back, the lender must charge interest and report the interest as taxable income.  If the interest is paid, but later gifted back to the borrower, it is still taxable income to the lender.  Gifts are not tax deductible and do not reduce taxable income.