Should you charge interest on a family loan? (And what the IRS thinks)
Charging interest to a family member feels wrong to a lot of people. A LendingTree survey found only 11% of private borrowers were charged any interest at all.
But there is a wrinkle most people never hear about: above a certain size, the IRS may treat your interest-free loan as though you charged interest — and tax you on money you never received.
This is general information, not tax or legal advice. Talk to a professional before acting on it.
The below-market loan rule
Under Internal Revenue Code § 7872, a loan is "below-market" if it charges less interest than the applicable federal rate, the AFR — a set of minimum rates the IRS publishes monthly.
When a loan is below-market, the foregone interest is treated as if it were transferred from you to the borrower, and then handed back to you as interest income. You may owe tax on interest you never actually collected, and the transfer may count against gift tax reporting.
The exceptions that cover most real loans
The $10,000 de minimis exception. § 7872(c)(2) says the section does not apply on any day when the total outstanding loans between the two individuals do not exceed $10,000. Most loans between friends never come close — recall that the average family loan in the FinanceBuzz survey was $2,676.
The $100,000 threshold. Below it, § 7872(d)(1) caps the amount treated as retransferred at the borrower's net investment income for the year. If the borrower has little or no investment income, the imputed interest can be little or nothing. That relief stops applying on any day the total exceeds $100,000.
So: small loans between individuals are usually outside this entirely. Large ones are not, and that is where it pays to check the current AFR before deciding to charge nothing. The IRS publishes the rates monthly at irs.gov under "Applicable Federal Rates" — check the current figure rather than trusting any number you read in an article, including this one.
Gift tax, briefly
If a loan is forgiven, or if it was never really meant to be repaid, it starts to look like a gift. For 2026, the annual gift tax exclusion is $19,000 per recipient — below that, no gift tax return is generally required.
There is a related trap. In Estate of Bolles v. Commissioner, decided by the Ninth Circuit in April 2024, the court restated a principle worth knowing: transfers within a family are presumed to be gifts. For one to count as a loan there must have been "a bona fide creditor-debtor relationship... characterized by a real expectation of repayment and intent to enforce the collection of the indebtedness."
In that case, payments from a mother to her son between 1985 and 1989 were loans, and those from 1990 to 2007 were gifts — because by then no real expectation of repayment existed. (It is an unpublished memorandum disposition in a federal estate and gift tax context, not a general rule of state contract law.)
The practical takeaway is uncomfortable but simple: a loan you never document, never track, and never ask about starts to look like a gift — to the IRS, and eventually to the borrower too.
So should you charge interest?
Three reasonable positions.
Nothing, and say so. Fine for small, short loans. Just make it explicit, so nobody has to guess.
At the AFR. The clean middle. It keeps the loan outside the below-market rules and gives you a defensible number that is not a judgment about the person.
Market rate. For large amounts, long terms, or when the borrower could have gone to a bank and chose not to.
Whatever you pick, the decision that matters more than the rate is how partial repayments are applied — interest first, or straight to principal. Settle that before the first one arrives, not after.