Can I Loan Money to My Child? IRS Rates, Paperwork, and Taxes

Yes, you can loan money to your child, and the IRS will respect the arrangement as a loan rather than a gift if you charge at least the Applicable Federal Rate (AFR) for the loan’s term, put the terms in a signed promissory note, and treat it like a real debt from that day forward. Miss any of those pieces and the IRS can reclassify the whole amount as a gift, which may force you to file a gift tax return and chip away at your lifetime exemption.¹

The Minimum Interest Rate You Have to Charge

Federal tax law requires a family loan to carry interest at or above the AFR published for the month the loan is made. Charge less, and the shortfall is treated as a gift from you to your child. That imaginary gift, called forgone interest, can push you over the annual gift tax exclusion even though no additional money actually moved.¹

The AFR comes in three tiers, and the tier you use depends on how long the loan lasts:

Short-term, for loans repaid within three years
Mid-term, for loans repaid in more than three years but no more than nine
Long-term, for loans running beyond nine years

The IRS updates all three every month.² For a fixed-term loan, the rate on the day you make the loan is the rate you lock in. For a demand loan, which you can call in at any time, the short-term rate applies and moves with the market.¹

Because longer terms carry higher rates, timing matters. A parent helping a child buy a home over 15 years who locks in a favorable long-term AFR during a low-rate month can hand their child a lower rate than any bank would offer while still satisfying the IRS.

Small-Loan Exceptions

Two exceptions relieve smaller loans from the AFR rules. If the total outstanding balance between you and your child never exceeds $10,000, the below-market loan rules don’t apply and you don’t have to charge any interest. This exception disappears if your child uses the money to buy income-producing assets like stocks or a rental property.¹

For loans between $10,001 and $100,000, the imputed interest you have to report is capped at your child’s net investment income for the year. If your child earns less than $1,000 in net investment income, the imputed interest is treated as zero and you owe nothing on phantom interest. This exception falls away if tax avoidance is a principal purpose of the loan.³

What the Paperwork Has to Say

The document that turns a family transfer into a loan is a written promissory note, signed before any money changes hands. Without one, the IRS has little reason to see the transfer as anything other than a gift. A workable note includes:

The exact principal amount
The interest rate, at or above the AFR for the applicable term on the date of the loan
A repayment schedule with specific due dates
A maturity date by which the full balance must be repaid
Full legal names and addresses for both parties
A description of any collateral securing the loan

Both of you sign. Notarization isn’t required in most states for a promissory note to be enforceable, but it strengthens the paper trail; notary fees usually run $5 to $10 per signature.

The note is only the beginning. The IRS also looks at whether the two of you actually behave like lender and borrower. Your child needs to make the scheduled payments, and you need to deposit them. If years pass with no payments and no reminders, an auditor will conclude the loan was really a gift from the start.

What You Owe in Taxes as the Lender

Every dollar of interest you collect is taxable income. You report it on Schedule B of Form 1040 if the total interest you received for the year exceeds $1,500; below that, it still counts as income and belongs on your return.⁴

If you lent below the AFR (including at zero interest), you owe income tax on the forgone interest too, even though it never reached your bank account. The IRS treats it as though your child paid it and you received it.³

Family loan interest is taxed at ordinary income rates, which range from 10% to 37% for 2026 depending on your total taxable income.⁵ A running ledger that breaks each payment into principal and interest makes tax time much easier.

On the gift-tax side, the 2026 annual gift exclusion is $19,000 per recipient. If forgone interest plus any other gifts to the same child stays under $19,000, no gift tax return is required. Amounts above that count against your lifetime gift and estate tax exemption, which sits at $15 million for individuals in 2026.⁶

Loans Secured by a Home

If your child uses the money to buy a home and you record a mortgage or deed of trust against the property with the local county recorder, your child may be able to deduct the interest they pay you, just as they would on a bank mortgage.

The IRS requires three conditions for the mortgage interest deduction. Your child must sign a written instrument making the home collateral for the debt. That instrument must let you claim the property in a default. And it must be recorded or otherwise perfected under state law.⁷ Most intrafamily arrangements fail on the recording step. Without it, the debt is unsecured and the deduction disappears.

Recording also protects you. It creates a public lien that survives if your child later refinances, sells, or faces creditor claims. Recording fees vary by county.

Forgiving Part of the Loan Each Year

Some parents write the loan at the proper AFR and then forgive a portion of the principal each year as a gift. As long as the forgiven amount stays inside the $19,000 annual exclusion (or $38,000 if both parents participate), no gift tax return is needed.⁸

Your child owes no income tax on the forgiven amount, because canceled debt that qualifies as a gift is excluded from gross income under federal law.⁹ The IRS has confirmed that debt canceled as a gift falls outside the general rule that treats canceled debt as taxable income.¹⁰

Document each forgiveness in writing, recalculate the remaining balance, and keep the loan functioning as a loan between forgiveness events. A pattern of forgiving every scheduled payment and never collecting will invite the IRS to reclassify the whole arrangement as a gift from the start.

If Your Child Can’t Pay

If your child stops paying and you decide to forgive the balance, the tax result depends on how the forgiveness is characterized. Treated as a gift, it may require a Form 709 filing to the extent it exceeds the annual exclusion, and your child owes no income tax. Not structured as a gift, the canceled debt could be taxable income to your child.

If your child genuinely cannot pay and you want a tax benefit for the loss, look at the non-business bad debt deduction. You have to show the debt became completely worthless and that you took reasonable steps to collect, such as written demands. Going to court isn’t required if you can demonstrate a judgment would be uncollectible.¹¹

A worthless non-business debt is treated as a short-term capital loss and reported on Form 8949. It offsets capital gains dollar-for-dollar, and up to $3,000 of any remaining loss can offset ordinary income each year ($1,500 if you file married filing separately). Unused losses carry forward.¹²

Simply deciding not to collect is not enough. Without a written promissory note, evidence of actual payments over the life of the loan, and documented collection attempts, the IRS will treat the loss as a personal choice rather than a deductible one. Keep the records related to a bad debt deduction for seven years, longer than the standard three.¹³

1
Office of the Law Revision Counsel. 26 USC 7872 – Treatment of Loans With Below-Market Interest Rates
2
Internal Revenue Service. Applicable Federal Rates (AFRs) Rulings
3
Office of the Law Revision Counsel. 26 US Code 7872 – Treatment of Loans With Below-Market Interest Rates
4
Internal Revenue Service. About Schedule B (Form 1040), Interest and Ordinary Dividends
5
Internal Revenue Service. IRS Releases Tax Inflation Adjustments for Tax Year 2026
6
Internal Revenue Service. What’s New – Estate and Gift Tax
7
Internal Revenue Service. Publication 936, Home Mortgage Interest Deduction
8
Internal Revenue Service. Frequently Asked Questions on Gift Taxes
9
Office of the Law Revision Counsel. 26 US Code 102 – Gifts and Inheritances
10
Internal Revenue Service. Canceled Debt – Is It Taxable or Not?
11
Internal Revenue Service. Topic No. 453, Bad Debt Deduction
12
Office of the Law Revision Counsel. 26 US Code 1211 – Limitation on Capital Losses
13
Internal Revenue Service. How Long Should I Keep Records?