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Re IRS AFR Rate Table Please define the length of time ...

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Re: IRS AFR Rate Table
Please define the length of time for short, mid, and long-term loans. Also, what are the various % AFR''s? I am borrowing $300,000 from a personal friend and need to choose an interest rate that is acceptable to the IRS.
Submitted: 8 years ago.
Category: Tax
Expert:  The Guy Behind the Tree replied 8 years ago.
Actually, the lender is entirely within their rights to charge you zero interest BUT if they do, the IRS will ASSUME an interest rate and "impute" that rate to your friend's income.

On the other hand, if your loan is for business or investment purposes, whatever the interest rate is, that interest expense COULD be deductible for you.

Six month CD rates from banks are in the range of 3-4% these days, depending on how hungry they are for your funds.

Home loans are about 6-7%, secured by real estate.

The vacant lots I am selling carry an interest rate of 9% for people who want to make payments instead of paying all cash.

If your loan is short term (under 1 year) you are quite safe using 4% to 5%. If your loan is medium term (1-3 years) I would use 6%. For a longer term I would use 7%. These are reasonable, an approximation of market rates, and are unlikely to arouse any undue attention should either of you get audited.
Customer: replied 8 years ago.
But the current interest rate for long term on the IRS "AFR Table" is as follows:
AFR        4.13%
110%AFR     4.55%
120%AFR     4.95%
130%AFR     5.36%
Can I use the 4.13% ? What do the others mean?
Expert:  The Guy Behind the Tree replied 8 years ago.
The IRS itself uses Applicable Federal Rates for certain purposes. They are discussed here:

The Federal definitions for short, intermediate and long term loans are also defined there. Their cutoffs are 3 and 9 years (under 3 is "short", between 3 and 9 is "intermediate", and over 9 is "long".)

Note at the bottom of the cited page, the Blended Annual Applicable Federal Rate for 2007 at 4.92%. The text advises the use of specified rates for given loan originations, and cites the specific revenue rulings.

But in my experience, using an attractively low rate for a commercial loan (not "shareholder-corporation" or other "insider" situation) risks a review by IRS auditors. Few if any "arms-length" transaction between willing borrowers and lenders are made at rates as low as some of the tables imply. The IRS can impute a higher rate if they feel the circumstances warrant.
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