Parent fears IRS trouble for late loan payments
Q: I lent my daughter money to buy a home. It has been a couple of years since she made a payment to me. That’s mostly due to COVID-19 shutdowns of her work and her health issues. Her home has continued to appreciate. I am completely confident that I will eventually receive the repayment of the principal she owes along with the interest that she has failed to pay. It’s more important to me that she and the children continue to have a roof over their heads. Is the IRS going to come after me if she doesn’t pay the interest that’s due? The mortgage is recorded, but it may be several more years before she starts paying monthly again. A:
Let’s recap: You helped your daughter and lent her money to purchase a home. In turn, you had her sign a promissory note and a mortgage to secure the repayment of the money you lent to her.
At this point you have a nonperforming loan. In other words, your borrower — your daughter — still owes you money, but has not paid you the interest or principal on the loan that was due. Are you concerned that the IRS will somehow think that you are giving your daughter a gift equal to the interest and principal due because she hasn’t been paying as agreed?
Relax. We don’t think the IRS has any reason to come after you. The only reason the IRS would be concerned would be if you failed to file a gift tax return for any money you gifted your daughter in excess of the annual allowable amount. At this time, the IRS allows you to gift up to $17,000 per year without triggering a gift tax return to the IRS. If you’re married, you and your spouse can gift your daughter up to $34,000 per year without filing IRS paperwork. But this isn’t a gift. You expect her to repay you, even if that repayment will come when she ultimately sells the property. That isn’t a gift. It’s flexibility in the repayment terms.
What you should know is that the IRS requires a minimum interest rate on loans. If you charge a lower interest rate, the IRS could consider the loan as a gift and require additional filings. For example, if you had given the loan to your daughter and not charged her any interest on the loan, the IRS would say that the interest you should have charged was a gift from you to her.
The IRS publishes a schedule of rates on its website that you can use to determine a rate of interest between family members, friends or others that will not go against IRS rules.
For example, the applicable federal rate for a longterm loan in the schedule published in September 2023 was between 4.11% and 4.19%. Given this schedule, if you charged a friend or relative that interest rate or higher, you’ll be in compliance with IRS requirements. However, if you charged your daughter 1% on a 30-year loan, the IRS would treat the difference between the 1% rate and the current published rate as a gift to your daughter. (To be clear, you don’t have to change the interest rate on your loan every year. The minimum interest rate you need to charge is the rate that was set when you gave the loan.)
If your daughter has not paid you interest because she has not had the financial means to pay but still intends to pay you, you may be OK with the IRS. We’ll leave that determination for an expert on tax law in this particular area. Given that you have not forgiven the loan and still expect to be repaid, the simple fact that a borrower has missed one or more payments doesn’t mean you should expect trouble from the IRS.
You still have a recorded loan. Once your daughter starts repaying her loan, you can log those payments into the amount your daughter owes. When and if she sells the home, and you get fully repaid on the loan, she’d be “paid as agreed.” Just remember that when your daughter pays you interest on that loan, you need to declare that interest as income. Likewise, if your daughter has not paid you, there is no income from her to declare.
We hope this helps, but if you need more information, you can contact the IRS, a tax attorney or an enrolled agent.