By Harry Prabandham · Updated September 27, 2026
Personal Finance
Borrowing From Family: How Intrafamily Loans Work
An intrafamily loan charges at least the IRS applicable federal rate and is documented like a real loan, so it is not treated as a gift.
Borrowing From Family: How Intrafamily Loans Work
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What is an intrafamily loan?
- It is a documented loan between relatives that charges interest at or above the IRS applicable federal rate (AFR).
- The IRS publishes AFRs monthly for short-term (up to 3 years), mid-term (over 3 to 9 years), and long-term (over 9 years) loans.
- A term loan generally uses the AFR for the month it is made; a demand loan's rate floats.
- Charging less than the AFR brings in Section 7872, which can treat forgone interest as both a gift and taxable income to the lender.
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Full Guide
What is an intrafamily loan?
- It is a documented loan between relatives that charges interest at or above the IRS applicable federal rate (AFR).
- The IRS publishes AFRs monthly for short-term (up to 3 years), mid-term (over 3 to 9 years), and long-term (over 9 years) loans.
- A term loan generally uses the AFR for the month it is made; a demand loan's rate floats.
- Charging less than the AFR brings in Section 7872, which can treat forgone interest as both a gift and taxable income to the lender.
When do families use them?
- To fund an option exercise or the resulting tax when startup shares cannot yet be sold.
- To help with a home purchase or down payment, sometimes secured by a recorded mortgage.
- To bridge a gap until an expected liquidity event, recognizing the event may be delayed or never happen.
- As an estate-planning tool: growth above the AFR on borrowed money builds up with the borrower, outside the lender's estate.
Are small loans exempt from the imputed-interest rules?
- Gift loans totaling $10,000 or less between two individuals are generally exempt, unless used to buy income-producing assets.
- For gift loans up to $100,000, imputed interest is limited to the borrower's net investment income, and treated as zero if that is $1,000 or less.
- That $100,000 exception does not apply if tax avoidance is a principal purpose of the loan.
- Above those levels, charging at least the AFR is the usual way to stay outside the rules.
How is the interest taxed on each side?
- The lender reports interest received as income.
- The borrower can deduct interest only in limited cases, such as qualified mortgage interest on a secured, recorded home loan or investment interest up to net investment income.
- Interest on a loan used for personal spending is generally not deductible.
- Forgiving interest or principal is a transfer without full payment, which the IRS defines as a gift; amounts above the $19,000 annual exclusion (2026) require a gift tax return.
What makes a family loan hold up if questioned?
- A signed promissory note stating the amount, rate, term, and payment schedule.
- Payments actually made on schedule, with records kept by both sides.
- A realistic expectation of repayment, given the borrower's income and assets.
Should it be a loan or a gift?
- A gift is simpler, but it uses exclusions or lifetime exemption and the money does not come back.
- A loan preserves the lender's capital and can keep things even among siblings.
- Agree in advance what happens if the borrower cannot pay or the lender dies, since the note becomes an estate asset.
- An attorney and CPA can help structure and document either path; Rubric Advisors does not prepare tax returns or provide legal advice.
Key takeaways
- Loans that charge at least the AFR for their term, and are put in writing, generally stay outside the below-market loan rules.
- Treating the loan like a real loan, with scheduled payments and records, matters as much as the rate.
- Interest deductibility for the borrower is limited and depends on how the money is used.
- Forgiveness is a gift, so it is usually handled as a deliberate, documented decision rather than a casual one.
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