The coronavirus has left many people scrambling financially. If you’ve noticed a loved one struggling and decided to help them out with a loan, be smart about it. Here’s what you should know about making a loan in the most family- and tax-friendly way possible.
Call Out the Loan
As Marketwatch reports, no matter what the interest rate you’ve decided upon, make sure you explain in writing that this is a loan. The same goes if you decide to not charge interest. Marking the transaction as a loan will help protect you if the loan ends up not being repaid. If the loan does go bad, you can claim a non-business bad debt deduction on your 1040. Without a written document citing a loan, the bad transaction will be deemed a gift — which does not result in deductions — by the IRS.
Make sure there’s no chance of a “gift” designation by adding lots of details to your loan document. You’ll want to include the loan’s interest rate, a set payment schedule, any collateral and an explanation of why you believe the recipient will repay you.
Know the AFR
Many loans to loved ones will include an interest rate that is below the current market. Just make sure you are using the applicable federal rate (AFR) as a barometer for the interest rate. Using the AFR as your rate will allow you to avoid undesirable tax implications.