How to Calculate AFR: Tiers, Compounding, and Imputed Interest

To calculate AFR interest, match your loan to one of the IRS’s three term tiers, pull that tier’s rate from the Revenue Ruling for the correct month, pick the column that matches your compounding frequency, and run the principal through a standard compound interest formula. Learning how to calculate the AFR comes down to those four inputs: term length, month, compounding period, and principal. For March 2026, the rates you’d be working with range from 3.53% to 4.72%.¹

Step 1: Identify Your Loan’s Tier

The IRS sorts every loan into one of three tiers based on the repayment period written into the agreement:

Short-term: three years or less.
Mid-term: more than three years, up to nine years.
Long-term: more than nine years.

These tiers come from Internal Revenue Code Section 1274(d), which ties each one to the yield on U.S. Treasury obligations of similar maturity.² The tier depends on the repayment schedule, not the dollar amount or the type of borrower. A five-year loan to your daughter and a five-year loan to a business partner both use the mid-term rate.

Step 2: Decide Whether It’s a Term Loan or a Demand Loan

A term loan has a fixed maturity date. A demand loan is payable whenever the lender asks for the money back, with no set end date. That distinction changes which month’s rate you use and whether it ever resets.

For a term loan, lock in the AFR in effect on the day the loan was made, compounded semiannually. That rate stays with the loan for its life, regardless of what happens to rates afterward.³ For a demand loan, use the federal short-term rate, and reset it each period you’re calculating forgone interest for. Demand loans stay short-term in the IRS’s eyes no matter how many years they remain outstanding.

Step 3: Pull the Rate From the Right Revenue Ruling

The IRS publishes new AFRs every month in a Revenue Ruling, archived on its Applicable Federal Rates page.⁴ Rulings are named like “Rev. Rul. 2026-6,” where 2026 is the year and 6 is the sequential number. The archive runs back to January 2000 in reverse chronological order.

Open the ruling for the month your loan originated (or, for a demand loan, the month you’re calculating). Each PDF contains several tables. Table 1 is the one you want for a standard private loan. The table also has rows for 110%, 120%, and 130% of the AFR, which apply to specific transactions like sale-leasebacks (110% AFR). For an ordinary loan, use the base AFR row and ignore the multipliers.

Step 4: Pick the Compounding Column

Table 1 is a grid: rows for each tier (short, mid, long) and columns for each compounding frequency (annual, semiannual, quarterly, monthly). Use the column that matches your loan agreement. If the agreement is silent, semiannual is the statutory default under Section 1274(d).²

Here is what Table 1 looks like for March 2026:

Short-term AFR: 3.59% annual, 3.56% semiannual, 3.54% quarterly, 3.53% monthly
Mid-term AFR: 3.93% annual, 3.89% semiannual, 3.87% quarterly, 3.86% monthly
Long-term AFR: 4.72% annual, 4.67% semiannual, 4.64% quarterly, 4.63% monthly

The rates drop slightly as compounding frequency increases. More frequent compounding produces more total interest from the same nominal rate, so the IRS lowers the stated percentage to keep the effective yield roughly equivalent across columns.¹

Step 5: Run the Numbers

With annual compounding, multiply the loan balance by the rate as a decimal. A $50,000 loan at the 3.93% annual mid-term AFR produces $1,965 in interest for the first year ($50,000 × 0.0393).

For any other frequency, use the standard compound interest formula:

A = P × (1 + r/n)^(n × t)

P is the principal, r is the annual rate as a decimal, n is the number of compounding periods per year (2 semiannual, 4 quarterly, 12 monthly), and t is the number of years. Total interest is A minus P.

Work the same $50,000 loan at 3.87% compounded quarterly over five years:

A = $50,000 × (1 + 0.0387/4)^(4 × 5) = $50,000 × (1.009675)^20 ≈ $60,629

Total interest: about $10,629. Notice how close that is to the annual-compounding result at 3.93%. That’s the effective-yield equivalence the IRS builds into the columns.

Seller-Financed Property Sales: The Three-Month Lookback

If your loan comes out of a sale of property with seller financing, you don’t have to accept the AFR for the closing month. You can use the lowest AFR from the three-month window ending with the month of the sale, or the month a binding written contract was signed, whichever produces the lower rate.⁵ Pull the Revenue Rulings for those three months, compare the AFR for your tier and compounding period across all three, and use the lowest.

Why the Calculation Matters: Imputed Interest

Charging less than the AFR, or nothing at all, doesn’t make the interest disappear. The IRS imputes it. Lend a friend $20,000 for one year at 0.1% and you collect $20 in actual interest. If the short-term AFR is 3.59%, the IRS says you should have collected $718. The $698 gap is forgone interest, and you owe income tax on it even though the money never reached your account.³

The forgone interest is treated as though it moved in two directions: first from the lender to the borrower (as a gift, compensation, or dividend depending on the relationship), then back from the borrower to the lender as interest income. Section 7872 applies this rule to gift loans between family members or friends, compensation-related loans between employers and employees or contractors and clients, corporation-shareholder loans, and any loan structured principally to avoid federal tax.

For gift loans, the deemed transfer can eat into the lender’s annual gift tax exclusion (2026: $19,000 per recipient) or lifetime exemption ($15,000,000).⁶ For a loan from an employer, forgone interest becomes additional wages. For a corporation-shareholder loan, it becomes a distribution.

When You Don’t Have to Run the Calculation

Section 7872 carves out two safe harbors based on the loan amount, and either one can spare you the imputed-interest math entirely.

The $10,000 exception: if total outstanding loans between two individuals stay at or below $10,000, Section 7872 doesn’t apply. You can lend a sibling $8,000 interest-free with no imputed interest consequences. The exception disappears if the borrower uses the money to buy or carry income-producing assets like stocks or rental property.³

The $100,000 rule: for gift loans between individuals where the total outstanding balance stays at $100,000 or less, the imputed interest the lender must report is capped at the borrower’s net investment income for the year. If the borrower’s net investment income is $1,000 or less, it counts as zero and the lender reports nothing.⁷ This cap doesn’t apply if tax avoidance was a main purpose of the loan, and it disappears entirely once the balance crosses $100,000. Above that line, run the full AFR calculation regardless of investment income.

1
Internal Revenue Service. Revenue Ruling 2026-6
2
Office of the Law Revision Counsel. 26 USC 1274 – Determination of Issue Price in the Case of Certain Debt Instruments Issued for Property
3
Office of the Law Revision Counsel. 26 USC 7872 – Treatment of Loans With Below-Market Interest Rates
4
Internal Revenue Service. Applicable Federal Rates (AFRs) Rulings
5
eCFR. 26 CFR 1.1274-4 – Test Rate
6
Internal Revenue Service. What’s New – Estate and Gift Tax
7
Internal Revenue Service. Publication 550 (2025), Investment Income and Expenses