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Barbara
Barbara, Enrolled Agent
Category: Tax
Satisfied Customers: 3101
Experience:  18+ years of experience in tax preparation; 25+ years of experience as a real estate/corporate paralegal.
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Is the interest earned from a loan to a family member

Customer Question

Is the interest earned from a loan to a family member taxable?
Submitted: 1 year ago.
Category: Tax
Expert:  Barbara replied 1 year ago.

Welcome to Just Answer. My name is ***** ***** I will be happy to assist you today.

As long as you're not in the personal-loan business, it doesn't matter whether you make the loan with the intention of earning some interest income or as a favor to a friend or family member in need – every dollar of interest you collect must be included on your tax return. The interest is taxed as ordinary income, which is how most other income, such as your salary and self-employment earnings, is taxed.

When the interest rate charged on a gift loan is less than the market interest rate – meaning banks and other financial institutions would charge higher rates of interest on the same loan – the below-market interest loan rules apply, and the IRS will require you to include “foregone interest” on your return. Foregone interest is the difference between the actual interest rate you charge and the applicable federal interest rate. In other words, regardless of the interest you collect, the minimum you'll have to pay tax on is the amount you would've collected had you charged the applicable federal interest rate instead.

The below-market rules will not apply at any time the outstanding loan balance is $10,000 or less, provided the borrower doesn't use the funds to purchase income-producing property, such as investments. For example, if you lend your sister $9,000 to purchase a car, the below-market rules don't apply to the loan. But if she buys stocks instead, you'll need to report the foregone interest on your return.

Interest from a personal loan is always reported on the “Taxable interest” line of your tax return. But if your total interest income for the year – not just the interest collected on the loan – is more than $1,500, you'll need to report it on Schedule B of your return. Schedule B just requires some of the details surrounding your interest earnings. For the personal loan, this means you'll need to enter the borrower's name and the total amount of interest you collected from him.

The following links contain additional information you will find helpful:

https://www.irs.gov/pub/irs-pdf/p550.pdf

http://finance.zacks.com/pay-taxes-interest-collected-personal-loan-10164.html

http://www.forbes.com/2009/10/29/family-loans-taxes-personal-finance-parents-loan.html

http://www.fivecentnickel.com/2011/10/31/are-personal-loans-taxable/

Please let me know if you require further information or clarification.

Thank you and best regards,

Barb

Expert:  Barbara replied 1 year ago.

Just following up with you to see if you have any other questions. If so, please come back to me here at your convenience, and I will be happy to assist you. If not, please take a moment rate my answer since that is the only way I receive credit for answering you and alerts Just Answer to compensate me for a portion of the fee you previously paid.

Best regards,

Barb