Gifting of Interest

[Snaggletooth]

Parent loans $100,000 to son on an interest-free loan. Loan is legitimate, with a 5-yr payback.

IRS says there is no such thing as an interest-free loan. If we were to impute interest at 5%, then interest would accrue at $5000 in the first year, prior to the first $20,000 being paid.

If parent "gifts" the $5000 interest to son such that the entire $20,000 is credited to principle, does the parent still have to report the interest? Of course, the parent would also have to reduce the $13000 annual gift allowance by the amount of this interest each year the loan draws interest.

[Gretel]

Not based on knowledge just on my gut feeling: Parents are still considered having received the interest. Otherwise the imputed interest ruled don't make much sense, being used anyway only if interest is not to be paid.

[Snaggletooth]

Understand

Understand the mindset of Gretel, and for those who may feel that the interest must first be received for it to be even available as a gift to begin with.

However, there are also rules about having to actually receive this interest before the payer can deduct it. If payer receives interest as a gift then presumably he can't deduct it (provided it was deductible on Sch A or as business interest to begin with).

The donor is also charged with reducing his otherwise gifting exemption as well by failing to include the interest as income, so there actually is an economic effect to the imputing of interest.

I think this one can go either way, and invite more comments. Thanks, Gretel.

[New York Enrolled Agent]

Parent loans $100,000 to son on an interest-free loan. Loan is legitimate, with a 5-yr payback.

IRS says there is no such thing as an interest-free loan. If we were to impute interest at 5%, then interest would accrue at $5000 in the first year, prior to the first $20,000 being paid.

If parent "gifts" the $5000 interest to son such that the entire $20,000 is credited to principle, does the parent still have to report the interest? Of course, the parent would also have to reduce the $13000 annual gift allowance by the amount of this interest each year the loan draws interest.

The IRS doesn't say there is no such thing as an interest-free loan. You CAN have interest-free loans without imputing interest. §7872(d) provides an exception for gift loans of upto $100,000 if the son (the borrower) has net investment interest of $1,000 or less.

[Snaggletooth]

Already Done

NYEA thanks. Problem is, parent has ALREADY loaned son $100,000 to improve his house and it is an interest-free loan per §7872.

The recent loan is yet another $100,000 (for purposes of this discussion).