What Is a Gift Loan? Imputed Interest, Exemptions, and Form 709

A gift loan is a loan between individuals that charges no interest or an interest rate below the IRS’s monthly benchmark rates. Under 26 U.S.C. § 7872, the IRS treats the forgone interest as though the borrower paid it to the lender and the lender handed it back as a gift.¹ That fiction has real consequences: the lender owes income tax on interest never actually received, and the deemed gift may need to be reported on Form 709. Several exceptions soften the impact for small and mid-sized family loans, but only if the loan is documented and the numbers stay inside the thresholds.

What Makes a Loan a Gift Loan

The defining feature is donative intent. A gift loan is any below-market loan where the forgone interest is “in the nature of a gift” — meaning you’re lending to help someone rather than to earn a return.¹ In practice that covers most loans between family members and close friends where the rate is zero or noticeably lower than what a bank would charge.

The classification applies even when the borrower fully intends to repay every dollar of principal. A $50,000 interest-free loan to an adult child is still a gift loan, because the benefit of not paying interest has measurable value. That value is what the tax rules target.

A gift loan is not the same thing as a gift letter used in mortgage lending. When a relative helps with a down payment, the mortgage lender requires a signed letter confirming no repayment is expected.² That is an outright gift. A gift loan carries an obligation to repay the principal; only the interest piece is treated as gifted.

How Imputed Interest Is Calculated

The IRS publishes applicable federal rates (AFRs) each month, split into three tiers based on the loan’s duration. For March 2026, the base rates compounded annually are roughly 3.59% for short-term loans of up to three years, 3.93% for mid-term loans of three to nine years, and 4.72% for long-term loans of over nine years.³ For a term loan, you lock in the rate in effect when the loan is made. For a demand loan you can call in at any time, you use the short-term rate in effect for the current period.¹

Imputed interest is the gap between what the borrower would have paid at the AFR and what they actually paid. Federal law treats that phantom amount as if two things happened at once: the borrower paid the interest to the lender, and the lender gifted the same amount back.¹ No cash moves, but the lender owes income tax on the interest and may owe gift tax reporting on the transfer.

Lenders report imputed interest as taxable interest on Schedule B of Form 1040 if their total interest income for the year exceeds $1,500.⁴ The borrower can deduct the imputed interest only when the underlying use would qualify anyway, such as mortgage interest on a qualified residence or interest on business funds. A zero-interest loan a child uses for personal spending produces no deduction on their side.

When Small Loans Are Exempt

If the total amount outstanding between you and one borrower stays at or below $10,000 on every day of the year, you generally do not need to calculate or report imputed interest at all.¹ This de minimis rule covers the everyday situations where parents float a few thousand dollars or friends help each other through a tight month.

The exception disappears if the borrower uses the money to buy income-producing assets such as stocks or rental property. In that case, the normal imputed interest rules apply no matter how small the loan is.¹ The restriction blocks the small-loan safe harbor from being used to move investment capital between family members tax-free.

The $100,000 Cap Tied to the Borrower’s Investment Income

This is the rule that changes the math for most mid-sized family loans. When the total outstanding balance between two individuals is $100,000 or less, the imputed interest counted as the lender’s taxable income is capped at the borrower’s net investment income for the year.¹ If the borrower has little investment income, the lender’s income tax exposure drops.

The math gets better still: if the borrower’s net investment income for the year is $1,000 or less, it is treated as zero. On a $75,000 interest-free loan to a child with minimal savings and no investment portfolio, the lender would owe no income tax on the imputed interest.¹ The gift side still applies, so the imputed interest is still treated as a gift for Form 709 purposes, but the income tax component goes away.

Two limits keep this from being abused. If the total outstanding loans between the two of you exceed $100,000 on any single day of the year, the cap is lost and the full imputed interest rules return. And the cap is unavailable if one of the principal purposes of the interest arrangement is federal tax avoidance. Setting the loan at $99,000 specifically to slip under the threshold can invite scrutiny.

When You Must File Form 709

Form 709, the United States Gift (and Generation-Skipping Transfer) Tax Return, is required when your total gifts to a single recipient in a calendar year — including any imputed interest treated as gifted — exceed the annual exclusion. For 2026, the annual exclusion is $19,000 per recipient.⁵ A $300,000 interest-free loan to your son plus a $10,000 birthday check can easily cross that line once the imputed interest is added.

Form 709 is due April 15 of the year after the gift. Filing Form 4868 for an income tax extension automatically extends the Form 709 deadline as well, but the extension covers only the filing, not any payment.⁶ Tax owed is still due April 15.

Filing does not mean you owe gift tax. The amount above the annual exclusion reduces your lifetime gift and estate tax exemption, which for 2026 is $15 million per individual.⁷ You will not actually pay the 40% gift tax rate until cumulative lifetime gifts and your estate exhaust that entire exemption. For most families, Form 709 is a tracking document rather than a tax bill. Skipping it still creates problems: without the filing, the IRS has no record of the transfer, which can complicate estate settlement later.

Splitting Gifts Between Spouses

Married couples can effectively double the annual exclusion by electing to split gifts. With both spouses’ consent, a gift made by one spouse is treated as made half by each, turning the $19,000 exclusion into $38,000 per recipient. Electing gift splitting requires both spouses to file their own Form 709, even if only one actually made a gift, and the consenting spouse’s Notice of Consent must be signed no later than April 15 of the following year.⁶

Documenting the Loan So the IRS Respects It

The single biggest mistake families make with gift loans is treating them casually. Without proper documentation, the IRS can reclassify the entire principal as an outright gift, not just the imputed interest, and that pulls a much larger number onto Form 709 in a single year.⁶

A written promissory note is the foundation. It should state the principal amount, the interest rate (even if it is 0%, so the IRS sees a deliberate choice), a specific repayment schedule with dates and amounts, a maturity date, and what happens if the borrower misses payments. Beyond the note, keep records of every payment: dates, amounts, and bank statements showing the transfers. An amortization schedule that matches the note terms makes the pattern easy to demonstrate if the IRS asks. The goal is for the arrangement to look like a real loan that happens to be between relatives.

Forgiving a Gift Loan

Forgiving a remaining balance is treated as a gift from the lender to the borrower for the amount forgiven.⁶ If you lent your daughter $80,000 and later cancel the remaining $50,000, that cancellation is a $50,000 gift in the year of forgiveness. Subtract the $19,000 annual exclusion and report the $31,000 balance on Form 709, applied against your lifetime exemption.

Good news for the borrower: when a debt is canceled as a gift, the borrower generally does not have to report the forgiven amount as cancellation-of-debt income.⁸ The tax consequence sits on the lender’s gift side, not the borrower’s income side.

If the lender dies with an outstanding balance, that balance is an asset of the estate. The estate either collects the remaining payments or, if the loan terms call for forgiveness at death, the cancellation is treated as a taxable transfer from the estate. Either way it factors into the estate tax calculation, which matters most on larger loans.

A Cleaner Path for Tuition and Medical Bills

Families helping with education or medical costs often have a better tool than a below-market loan. Payments made directly to a school for tuition, or directly to a medical provider for qualifying care, are excluded from gift tax entirely, with no dollar limit.⁹ This exclusion stacks on top of the $19,000 annual exclusion, so paying $60,000 in tuition directly to a university and separately gifting the same person $19,000 in cash triggers no Form 709 filing.

The rules are narrow about what qualifies. For education, only tuition counts — books, room and board, and supplies do not. For medical costs, the exclusion covers diagnosis, treatment, prevention, and health insurance premiums, but not expenses already reimbursed by the recipient’s insurance.⁹ The payment must go straight to the institution or provider. Writing a check to your grandchild who then pays the school does not qualify.

For large recurring expenses like graduate tuition, direct payment usually beats structuring the same help as a below-market loan with its imputed interest and reporting overhead. For one-time or mixed-use needs, a properly documented gift loan still has its place.

State Gift Taxes

Nearly every state defers to the federal gift tax system and imposes no separate gift tax of its own. Connecticut is currently the only state that levies an independent gift tax. If you live there or are gifting Connecticut property, check whether a state return is required alongside your federal Form 709. Everywhere else, the federal filing is the only gift tax concern.

1
Office of the Law Revision Counsel. 26 USC 7872 – Treatment of Loans With Below-Market Interest Rates
2
Fannie Mae. Personal Gifts
3
Internal Revenue Service. Rev. Rul. 2026-6 – Applicable Federal Rates for March 2026
4
Internal Revenue Service. Instructions for Schedule B (Form 1040)
5
Internal Revenue Service. IRS Releases Tax Inflation Adjustments for Tax Year 2026, Including Amendments From the One, Big, Beautiful Bill
6
Internal Revenue Service. Instructions for Form 709 (2025)
7
Internal Revenue Service. What’s New – Estate and Gift Tax
8
Internal Revenue Service. Topic No. 431, Canceled Debt – Is It Taxable or Not?
9
eCFR. 26 CFR 25.2503-6 – Exclusion for Certain Qualified Transfer for Tuition or Medical Expenses