Family “Friendly” Loans

The IRS does not seem to care when the aggregate amount of interest-free family loans is under $10,000. IRC §7872(c)(2)

But for better IRS tax advantages and possibly some legal advantages documenting the debt with checks (not currency), a signed note bearing a fair rate of interest and reasonable repayment terms, and a lien on the property of the borrower is the way to go.

Principal residence indebtedness
Qualified principal residence indebtedness includes:
Any debt incurred in acquiring, constructing, or substantially improving a principal residence that is secured with a mortgage lien on the principal residence
As well as any subsequent debt secured by the principal residence resulting from the refinancing of debt incurred to acquire, construct, or substantially improve a principal residence, but only to the extent that the amount does not exceed the amount of the refinanced indebtedness.

A principal residence is generally the home where the taxpayer lives most of the time. A taxpayer can have only one principal residence at a time. IRC §163(h)(3)   And the amount of debt that can be Qualified principal residence indebtedness is limited to $1,000,000 plus $100,000. IRC §163(h)(3)(B) & (C)

Often a parent will give or lend money to a child to buy a home, unless the debt is secured with a lien on the land records, the interest expense is not deductible, but the interest income is still fully taxable. Or a spouse may provide the cash for the down payment on the purchase of the couple’s principal residence. Sometimes, placing a properly documented lien on the property may protect it from other creditors.

Business indebtedness
Often a parent will give or lend money to a child to start a business.  Or a spouse may provide cash for the other spouse’s business needs. In such a case the interest can be deductible without a lien or UCC filing, but taxpayers may be advised to consult with a lawyer to have a lien place on the property.  By doing this the property may be protected for the family from other creditors or even from the IRS or State taxing authorities.

Investment property indebtedness
Similarly, placing a proper lien on the property may protect it for the family from other creditors including the IRS and State taxing authorities.