Below-market loan for mortgage - what does the borrower need to do?

[Hendrix]

Hello!

I have a question on a family loan. If it is less than $100K with 1% interest, and you buy a house with it.

What do you need to report as a borrower, and what is the tax consequence?

You have no investment income because you have not sold your stocks. You just have increased numbers in your portfolio, but you did not sell anything, so I believe it is zero investment income, apart from some bank interest.

Do you need to do anything, and therefore maybe more tax to pay?

[Opus 17]

Your question doesn't make sense, can you clarify?  You're talking about a loan to buy a house, and then you are talking about portfolios and income.  

Focusing just on this question,

I have a question on a family loan. If it is less than $100K with 1% interest, and you buy a house with it.

What do you need to report as a borrower, and what is the tax consequence?

Borrower

The borrower can not deduct this as a mortgage on schedule A unless the loan is secured by a lien on their property.   Assuming it is not, the borrower has nothing to report on their tax return.  Buying property is not taxable and is not reported (it might be taxable when sold).   Borrowing money is not taxable (unless you default and don't pay it back), you aren't earning interest you are paying interest, and you can't take a tax deduction for the interest.

If this is business property (like a rental) you can deduct the interest, even if the loan is not secured by the property, but you should have good documentation that shows the interest is tied to the building as an ordinary expense of doing business.

However, the lender has an issue

The IRS expects loan to be made in a businesslike manner, and that includes charging market rate interest.  The lender must charge interest, and report the interest as taxable income on their tax return, even if the borrower is a family member.  If the lender charges no interest or below market interest, they must still report and pay income tax on the interest they could have received if they had charged at least the applicable federal minimum interest rate.  This is variable, is reset every 3 months, and is currently about 4% APR.  This is called imputed interest.

https://www.irs.gov/applicable-federal-rates

[Mike9241]

I have a question on a family loan. If it is less than $100K with 1% interest, and you buy a house with it.

What do you need to report as a borrower, and what is the tax consequence?

some of the issues you face.

1)None of the interest would be deductible by you since it seems the house is not security for the loan.

2) since the loan is over $10,000 you are subject to IRC section 7872. It would appear to be a gift loan as defined in IRC 7872(c)(1)(A)

3) slightly different rules apply in the interest rate depending on whether this is a demand or term loan

7872 (f) (2)Applicable Federal rate
(A)Term loans
In the case of any term loan, the applicable Federal rate shall be the applicable Federal rate in effect under section 1274(d) (as of the day on which the loan was made), compounded semiannually.

(B)Demand loans
In the case of a demand loan, the applicable Federal rate shall be the Federal short-term rate in effect under section 1274(d) for the period for which the amount of forgone interest is being determined, compounded semiannually.

4) in either case the applicable federal rate is applied to the applicable balance and interest for the year is calculated and reported as interest income on the lender's return with an exception.

5) 

(d)Special rules for gift loans
(1)Limitation on interest accrual for purposes of income taxes where loans do not exceed $100,000
(A)In general
For purposes of subtitle A, in the case of a gift loan directly between individuals, the amount treated as retransferred by the borrower to the lender as of the close of any year shall not exceed the borrower’s net investment income for such year.

(B)Limitation not to apply where one of principal purposes is tax avoidance
Subparagraph (A) shall not apply to any loan the interest arrangements of which have as 1 of their principal purposes the avoidance of any Federal tax.

5)if these gifts along with other gifts between the lender and borrower exceed the annual gift tax exclusion gift tax returns must be filed. Form 709. Turbotax does not do this form. It does not calculate any linitation on reporting due to (d)(1)

[Opus 17]

@Mike9241 

All that you cite is the responsibility of the lender, correct?  The original question is about the borrower.  (But the lender should be made aware.)

[Hendrix]

The reason I brought up my portfolio is that on the lender side, if the borrower only has $1000 or less investment income, then it is an exception. First I thought it was mere income, but it says, "Investment" income. Now, this is on the lender side, and I cannot find information on the borrower side.

I am not looking for deduction. I am simply asking if the borrower needs to pay more tax to IRS if he borrowed $100K or less from a family member at 1% interest.

[Opus 17]

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@Hendrix wrote:

I am not looking for deduction. I am simply asking if the borrower needs to pay more tax to IRS if he borrowed $100K or less from a family member at 1% interest.

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Not as the borrower.  The family member making the loan has some things to be aware of and maybe report.  

And I still have no idea what you mean by having investment income.   Your family member can loan you any amount of money for any reason, no matter what your financial circumstances are.  If they charge below market interest, they have certain tax responsibilities.  It has nothing to do with your overall income or your investment income.  I would be curious to know where you got that information.

[Mike9241]

@Opus 17 true but i did post this

None of the interest would be deductible by you since it seems the house is not security for the loan.

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in addition, if it was secured by the home, the borrower would be able to deduct the imputed interest but also might be responsible for filing a gift tax return if gifting the imputed interest back to the lender and any other gifts the borrower makes to the lender exceed the gift tax threshold for the year.

[Hendrix]

As long as I don't have to pay extra tax as a borrower, I am fine. Thank you.

Imputed Interest on Below Market Loans | Individual Income Tax | Episode 20 - YouTube

It is mentioned at around 10:00. I've seen a couple different videos mentioning the same thing.

I might have seen that the difference between my 1% and AFR is considered as income for the borrower? Maybe I am totally mistaken.

[Opus 17]

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@Hendrix wrote:

As long as I don't have to pay extra tax as a borrower, I am fine. Thank you.

Imputed Interest on Below Market Loans | Individual Income Tax | Episode 20 - YouTube

It is mentioned at around 10:00. I've seen a couple different videos mentioning the same thing.

I might have seen that the difference between my 1% and AFR is considered as income for the borrower? Maybe I am totally mistaken.

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No, the lender must report the interest as income (using the AFR) even if they don't charge interest.  The borrower does not have income from interest not charged.  

I haven't watched the video, but it certainly could be wrong.