When you lend or borrow money to or from friends or relatives, you can avoid tax trouble by setting a market interest rate for the loan. If it’s better to charge a lower interest rate or no interest at all, you may be able to use these two tax code provisions:
* Loans up to $100,000. If the borrower’s net investment income is under $1,000, the lender will not recognize any income from the loan if little or no interest is paid. However, any net investment income over $1,000 will be attributed to the lender, up to the amount of foregone interest.
Say that Ruth Mason lends her daughter Margot $100,000 and receives no interest this year. If Margot gets $900 from dividends and interest and capital gains this year, for example, Ruth owes no income tax on the transaction. If Margot’s net investment income is $1,200 this year, Ruth must report $1,200 as taxable income.
* Loans up to $10,000. If the borrower does not use the money to buy an income-producing asset, the lender won’t owe any gift or income tax.
