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Loan repayment - tax ramifications?

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Mark2365

New member
In Arizona, a year ago, I loaned my brother $80K, so he could buy a house.
Now, he must sell it. The escrow company will issue a check to me for the $80K.
It is repayment of a non-interest loan.
How can I make sure that there are no state or fed tax ramifications?
Thanks.
Mark2365
 


davew9128

Junior Member
You need to determine the imputed interest you gifted your brother on the $80k. You can't just make a large loan to a related person without charging a minimum amount of interest.
 

quincy

Senior Member
You need to determine the imputed interest you gifted your brother on the $80k. You can't just make a large loan to a related person without charging a minimum amount of interest.
Could you please explain your statement, davew? Thanks.
 

Taxing Matters

Overtaxed Member
Davew9128 is correct. The tax law imputes interest in the case of loans made that are below market, though the rules do not apply if the total loans you make to another individual are $10,000 or less. I'll provide the same explanation of the rule I gave the OP on another forum for the benefit of readers here:

This is a below market loan to which the rules of the Internal Revenue Code (IRC) § 7872 apply. That section details the treatment of below market loans. You made the loan to your brother interest free, with the result that the foregone interest you otherwise would have gotten is a gift to him. Under § 7872, that means that interest is computed at the applicable federal rate (AFR) and that amount of interest is treated as (1) a gift you made to your brother and then (2) your brother then pays you that same amount in interest. That interest you are deemed to receive is known as imputed interest.

Assuming that your total gifts to your brother, including this imputed gift, do not total more than $15,000 for the year you won't have any gift tax issues to worry about. However, pay attention to the other gifts you make to him during the year because if the total of all the gifts combined exceed $15,000 you will have to file a gift tax return and reduce you lifetime unified credit against gift and estate taxes or, if you've exhausted that credit, you'll have gift tax to pay.

The imputed interest is included in your income like any other interest you receive. However, so long as the total loans between you and your brother are less than $100,000, the interest income you have will be limited to no more than your net investment income for the year.

You aren't going to be able to avoid the application of these rules.

Arizona residents compute their state income tax the same way they do for federal income tax, with a few adjustments that do not impact this.
 
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Taxing Matters

Overtaxed Member
Thanks. I didn't question the validity of dave's answer. I was curious. :)
I didn't think you were. The reason I provided the answer I did was to address that curiosity; others reading it would likely have the same question since the rules of § 7872 are not well known outside of tax professionals. I dare say that most people would not stop to consider that a zero interest loan might indeed result in tax issues. I credit the OP with being alert enough to ask the question rather than simply assuming that there are no tax consequences for this.
 

adjusterjack

Senior Member
How would the IRS find out about these intrafamily or intrafriend loans if they aren't reported by either party?

I'm not suggesting tax evasion but it seems to me that there must be millions of these loans that (inadvertently) never got reported.

Maybe enough tax to fund the Great Wall of Trumpa. :D
 

Mark2365

New member
You did, indeed, post an Extremely thorough reply to this query, Mr. Taxing Matters.
VERY Much appreciated.
(I came here after finding that this seems to be a more actively responsive forum.)
The only other question is... at What interest rate? Assuming it's for exactly 365 days,
a Google search, and https://www.investopedia.com/terms/a/applicablefederalrate.asp
tells me that 2.72% applies for this short-term loan. So, I "gifted" $2176 to him,
and he paid me that amount back, which I need to report as interest income. That's it,... yes?

Good question. Would the escrow company issue some 1099 like document?
Yeah,... a Good question. I'll ask Escrow company if they need to report this in some way.
Thanks very much, people.
Mark2365
 

Taxing Matters

Overtaxed Member
How would the IRS find out about these intrafamily or intrafriend loans if they aren't reported by either party?
The loan repayment will end up as part of the closing documents for the loan if it is paid out of escrow. During an audit, the IRS may indeed discover that loan and there is the possibility that the IRS would not only include the income and interest but also a penalty for failure to report the income.

I'm not suggesting tax evasion but it seems to me that there must be millions of these loans that (inadvertently) never got reported.
There are of course some of these gift loans that are never reported. Intentionally failing to include that income would be tax evasion, a federal felony offense.
 
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Taxing Matters

Overtaxed Member
The only other question is... at What interest rate? Assuming it's for exactly 365 days,
That would be a short term loan. You need to look at the AFR under § 1274(d) that was in effect in the month that the loan was made. The IRS publishes this monthly as a revenue ruling. Table 1 of the Revenue Ruling are the AFRs under section 1274. The first line of the table is the short term AFR, and you'd look at the semi-annual interest column. For example, if the loan was made in March 2018, you'd look at the ruling that gives the AFRs for March 2018. Looking at the semi-annual interest column that would be 1.95%. You'll find the rulings listed by month here: AFR revenue rulings
 

LdiJ

Senior Member
That would be a short term loan. You need to look at the AFR under § 1274(d) that was in effect in the month that the loan was made. The IRS publishes this monthly as a revenue ruling. Table 1 of the Revenue Ruling are the AFRs under section 1274. The first line of the table is the short term AFR, and you'd look at the semi-annual interest column. For example, if the loan was made in March 2018, you'd look at the ruling that gives the AFRs for March 2018. Looking at the semi-annual interest column that would be 1.95%. You'll find the rulings listed by month here: AFR revenue rulings
In other words, we are not talking about a huge amount of taxable income at all. Therefore, its far wiser to simply include the interest income on your tax return and pay whatever tax is due.
 
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