Would Personal Load be Taxable?

[RacknarockGod]

If a family member offer to an interest free loan to pay off a mortgage, is there any tax to be paid by either the mortgage owner or the generous family member? Would this set off IRS audit?

Thank you! 

[ScruffyCurmudgeon]

An "interest free loan" would be considered by IRS as the "foregone interest" being a GIFT by the person providing you  the pay-off amount.  This may or may not be an issue for the donor.  The donor will have the obligation to file a Form 709 Gift Tax return if the total amount of foregone interest in a given year amounts to more than $16,000 (in 2022; $17,000 in 2023) if you are the sole beneficiary of the gifted interest-free loan.   You on the other hand, if it is truly a gifted interest-free loan, would not be receiving any taxable income actual or imputed.  The donor should seek advice on the imputed interest percentage on the gifted amount, with the lowest % being that published and available with a monthly calculation:  "Applicable Federal Rates"

See also:  IRS Tax Rules for Imputed Interest 

[Opus 17]

There's nothing particular about this that would trigger an audit, although we don't know all the triggers.  In the unlikely event someone was audited, this is what the IRS would say:

Either it is a bona fide gift, or a loan.  If it's a gift, the giver must file a gift tax return if the amount is more than $16,000, although actual payment of gift tax is almost never required.  A gift has no expectation of repayment.

If it's a loan, then the IRS position is that taxpayers must conduct business in a businesslike manner.  The lender must charge at least the IRS minimum interest rate, and report the interest received as taxable income.   If the lender doesn't charge interest, they must still report imputed income equal to the amount of interest they would have received if they had charged interest.   The applicable federal interest rate is variable and changes monthly, if the loan was made in November 2022, the rate would be 3.85%. 

Now potentially, if the lender did charge interest, they could give that interest back to the homeowner (as a birthday gift, for example) as long as the lender reported the interest as taxable income first.  Either way, the IRS is going to want to see the lender reporting either their actual interest income or the interest they would have received if they charged the minimum allowable interest rate.

This is what the IRS wants, at any rate.  Most people are never audited. 

[RacknarockGod]

Should such loan be done electronically? 

Would it introduce any issue if the loan is given in cash to pay off a mortgage?

Would IRS see the cash as loan or income?

[Critter-3]

Should such loan be done electronically? Immaterial

Would it introduce any issue if the loan is given in cash to pay off a mortgage?  Immaterial

Would IRS see the cash as loan or income?   A  loan in any fashion is never considered income.  

[RacknarockGod]

Immaterial - Really?

How would one explains to IRS that it is a loan when a large amount of cash deposited into an account?

[Critter-3]

If it is more then $16K  then you should file a gift tax return  but gifts of any size are never reported as income to the receiver. 

[ScruffyCurmudgeon]

Any loan for which there is no corroborating documentation (paper, electronic, .et al) is ripe for problem, whether it be possible inquiries by tax authorities, local and state law inquiries as to the possibility of cash "washing," or simply arguments as to payback periods, loan amounts, or other terms, between the lender and the debtor, or even inter alios, such as family or related persons to the direct parties.  There is absolutely no benefit gained by not documenting properly a loan and considerable probability of problems by failing to do the documentation.

[Opus 17]

---

@RacknarockGod wrote:

Should such loan be done electronically? 

Would it introduce any issue if the loan is given in cash to pay off a mortgage?

Would IRS see the cash as loan or income?

---

It doesn't matter how the funds are transferred.

It doesn't matter what the funds are used for.

Audits are extremely rare, and an audit where the IRS looks at a person's bank account to see if they have mystery income that was not declared on the tax return are the rarest type of all.  If this will be a loan, the borrower and lenders should have a simple signed agreement that shows the amount of the loan, repayment terms and interest rate.  That will be enough to prove to the IRS that the funds were from a loan and not from undeclared work of some kind.