Yes. If you lend a family member more than $10,000, the IRS expects you to charge interest on that family loan at or above the Applicable Federal Rate (AFR). Charge less, and the tax code steps in: it calculates the interest you should have collected, taxes you on it as income, and treats the missing amount as a gift from you to the borrower. The rules sit in Internal Revenue Code Section 7872, which governs below-market loans.
When the Rule Actually Applies
The interest requirement kicks in once the total outstanding balance between you and the borrower crosses $10,000. If everything you’ve lent that person adds up to $10,000 or less on a given day, the IRS ignores the imputed interest rules for that day. You can lend interest-free within that limit without tax consequences.
One exception swallows that exception: if the borrower uses the money to buy or carry income-producing assets like stocks or rental property, imputed interest applies no matter how small the loan.
The Applicable Federal Rate
The AFR is a floor, not a ceiling. You only need to meet it, and most families use the exact AFR to keep payments as low as possible while staying compliant. The IRS publishes three tiers each month, keyed to how long the borrower has to repay:
- Short-term: three years or less
- Mid-term: more than three years, up to nine
- Long-term: more than nine years
For February 2026, the annual-compounding rates are 3.56% short-term, 3.86% mid-term, and 4.70% long-term. The rates move monthly with Treasury yields, and you lock in whichever rate is in effect the day you fund the loan. Each month’s numbers appear in the Internal Revenue Bulletin on the IRS website.
The rate you use also depends on the loan’s structure. A term loan has a fixed maturity date, and its AFR is locked in the month the loan is made and stays fixed for the loan’s life. A demand loan, which you can call in at any time, uses the short-term AFR and recalculates each period, so the imputed interest can fluctuate as rates move. Any loan that isn’t payable on demand is a term loan by default.
What Happens If You Charge Less Than the AFR
Charge nothing, or charge below the AFR, and the IRS creates two separate tax events out of the same shortfall.
First, imputed interest. The tax code calculates the interest you would have collected at the AFR and treats you as though you received it. You owe income tax on that phantom amount even though no cash changed hands. As the lender, you report it on your return: on Schedule B of Form 1040 if your total interest exceeds $1,500, or directly on line 2b if it doesn’t.
Second, a deemed gift. The same foregone interest is treated as a gift from you to the borrower. If your total gifts to that person for the year exceed the annual gift tax exclusion — $19,000 per recipient for 2026 — you have to file Form 709 and start drawing down your lifetime exemption. The lifetime exemption sits at $15,000,000 for 2026 following the increase enacted by the One, Big, Beautiful Bill signed into law on July 4, 2025, so most family lenders never owe actual gift tax. But skipping the Form 709 when it’s required can create penalties and complicate estate planning later, because the executor will need a complete gift history to calculate estate tax.
The timing of these events differs between loan types. With a demand loan, foregone interest is treated as transferred on the last day of each calendar year, so the tax obligation builds gradually. With a term loan, the entire discount — the difference between what you lent and the present value of the future payments at the AFR — is treated as transferred on the date the loan is made. That front-loaded treatment can create a much larger gift in year one.
The $100,000 Gift Loan Exception
Between $10,000 and $100,000, a helpful cap applies. For gift loans in that range, the imputed interest you must report as income is limited to the borrower’s actual net investment income for the year. If the borrower earned $800 in dividends and interest, you report at most $800, even if the AFR calculation would produce a larger figure. If the borrower’s net investment income is $1,000 or less, imputed interest is treated as zero for income tax purposes.
Once the outstanding balance crosses $100,000, the cap disappears and full AFR-based imputed interest applies. The $100,000 threshold aggregates all loans between you and that borrower, not each loan on its own.
Documenting the Loan So It Isn’t Recharacterized as a Gift
The bigger risk than getting the interest calculation wrong is having the IRS decide your “loan” was really a gift from day one. If that happens, the entire principal becomes a taxable gift in the year you transferred it.
Courts have looked at several factors when deciding whether a family transfer is genuine debt: whether a written promissory note exists, whether the borrower actually made payments on schedule, whether interest was charged at or above the AFR, whether there was a fixed maturity date, and whether the borrower had the ability to repay.
A workable promissory note covers the principal amount, the interest rate (at least the AFR in effect when funds transfer, with a reference to the specific revenue ruling), a repayment schedule with a final maturity date, default terms, and signatures dated on or before the day the money moves.
If the loan finances a home, consider recording a mortgage or deed of trust against the property. That protects you if the borrower sells or refinances, and it lets the borrower potentially deduct the interest as home mortgage interest on Schedule A. Without a recorded security instrument, family loan interest is treated as unsecured personal loan interest, which is not deductible for the borrower even if payments are made faithfully.
Forgiving the Loan Later
If you decide to forgive the remaining balance while you’re alive, the unpaid amount becomes a gift in the year you cancel it. Cancel $50,000 and you’ve made a $50,000 gift: the first $19,000 falls under the annual exclusion, and the remaining $31,000 chips away at your lifetime exemption.
Some families forgive loans in $19,000 annual installments to stay inside the exclusion. That approach works, but a pattern suggesting you never expected repayment lets the IRS recharacterize the original transfer as a gift from the start, with back taxes and penalties on the full amount. Continuing to charge the AFR, receiving actual payments, and documenting each partial forgiveness as a separate decision help preserve the debt characterization.
If you die with the loan outstanding, the unpaid principal plus accrued interest is an asset of your estate at its fair market value — presumed to be face value unless the executor can show the note is worth less or is uncollectible. A will that forgives the loan spares the borrower income tax on the canceled debt, because a bequest is excluded from taxable income; the forgiven balance still counts toward the estate’s value for estate tax purposes if the estate exceeds the $15,000,000 exemption.
A Practical Takeaway
If the loan will stay at $10,000 or less and isn’t funding investments, you can skip interest entirely. Above that, charging the AFR published for the month you fund the loan, papering the deal with a real promissory note, and collecting payments on schedule keeps the transaction clean. Skip those steps and you invite two tax hits — one on income you never received, one on a gift you never meant to make — from a loan that felt like a simple favor.