Parent's funding Home equity Loan to son.

[DMICPA]

Client is borrowing $40,000 from parents using personal residence as collateral. Client terms it a "home equity loan". Loan will be recorded as a 2nd Trust Deed.

Funds will be used for a variety of purposes including but not limited to home improvements.

Here is the clincher-Parent's are charging 10% interest. Don't know how they came up with this 10% amount but it seems higher than a lending institution would charge.

Considering that these are Related Parties, isn't there a limitation on the interest rate that can be charged and deducted as Home Mortgage Interest by the client?

One could make the case that the son's credit is bad or there is some reason for the high interest rate based on risk but generally a loan should be at fair market value.

I see a red flag.

Anyone have any ideas?

Bob

[JohnH]

Interesting, but maybe not such a red flag. Off the top of my head, I'd say IRS doesn't really care as long as there are valid business reasons for doing it and the parents report the income properly. Lending to a high-risk borrower might justify a higher rate, and depending upon how bad his credit is, 10% might be a bargain for him.

I think most IRS rules focus on below-market or non-interest bearing loans as a disguised gift, but that isn't the issue in this case. Now if it happens that he is wealthier than the parents, or if there are no supportable business reasons for the high rate, I suppose there could be some potential problems.

Sounds very much like a facts-and-circumstances issue.

[Roberts]

As long as the interest is declared by both sides appropriately, don't see a problem.