Mortgage lenders are increasingly cautious so some buyers may have to come up with larger down payments now. Thus, you might want to lend money to your children or grandchildren to help them buy a home. In that situation, your best strategy is to make a formal loan, signed by borrower and lender, and collect interest at the applicable federal rate (AFR), published monthly by the IRS.
If you make an interest-free or low-interest loan, foregone interest must be imputed and surprising tax results may occur. Suppose you make a $200,000 to your daughter, charging no interest, at the time the AFR is 5 percent.
* The imputed interest on that loan will be $10,000 a year: the 5 percent AFR times $200,000.
* Each year, you must recognize $10,000 worth of taxable interest income, although you haven’t received any money.
* Your daughter probably will be able to take a $10,000 interest deduction each year, on money she didn’t pay, assuming interest payments would have qualified as deductible interest.
* You also would be deemed to have made a $10,000 gift to your daughter, each year that she pays no interest, and you might be required to file a gift tax return.
