If below-market loans from one family member to another don’t exceed $100,000, no income tax consequences will apply. To avoid tax, the child’s net investment income (interest and dividends) must be no more than $1,000 each year.
Suppose Meg Parker makes an interest-free $100,000 loan to her son Art to buy a house, in 2005. On his 2005 tax return, Art reports $650 in income from interest on a bank account and mutual fund dividends. For the year, Art is under the $1,000 allowance so the loan from Meg has no tax consequences.
Suppose, instead, that Art has $2,650 in interest and dividend income this year. He’s over the $1,000 allowance so interest will be imputed. However, in this example, only $2,650 worth of interest income would be imputed to Meg, the lender. That’s true even if the market rate of interest is 4 percent and the interest foregone by Meg is $4,000: 4 percent of $100,000.
