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Interest-free loans to family: the tax rules, with a worked example

Yes, a parent can lend you money at 0%. The IRS doesn't forbid it. Above $10,000, though, the tax law may pretend interest was paid, and the lender may owe tax on money they never received. Here is how it works, in dollars.

Checked 2026-09-28 · All guides

General information from the tax code and IRS pages, checked 2026-09-28. Not tax advice: for your own situation, use the free help at the bottom of this page.

Can my parents give me an interest-free loan?

Yes. No IRS rule says family members must charge each other interest. The tax code (section 7872 of the Internal Revenue Code) only says what happens, tax-wise, when a loan charges less than the IRS minimum rate. That minimum is the applicable federal rate (AFR), which the IRS publishes every month. For a loan of 3 years or less made in October 2026, it is 4.25% a year. (How to find the right rate.)

A loan below the AFR, including 0%, is allowed. It just brings in the rules below.

What is imputed interest?

"Imputed" means "treated as if it happened". For a below-market family loan, the tax law pretends three things:

The lender charged interest at the AFR.
The lender gave the borrower that missing interest as a gift.
The borrower paid it straight back to the lender as interest.

No money moves. But on paper, the lender received interest, so the lender may owe income tax on interest they never got. And the missing interest counts as a gift from lender to borrower. The IRS calls it "forgone interest". It is treated as passing between you once a year, generally on December 31.

When the rule doesn't apply, or is limited

Two exceptions in the statute cover most family loans. Both apply only to gift loans made directly between individuals, and neither applies if avoiding tax is one of the main reasons for the 0% rate.

The $10,000 exception. On any day when all loans outstanding between the two people add up to $10,000 or less, section 7872 doesn't apply at all. Two limits:

It doesn't cover a loan used to buy or carry income-producing assets, such as stocks, bonds or a rental property.
A married couple counts as one person. Two parents lending to one child share a single $10,000 limit.

IRS Publication 550 words one part of this more broadly than the statute. It says the $10,000 exception doesn't apply to term loans, and that the rules keep applying even after the balance falls to $10,000 or less. That is the rule for employer and company loans. For gift loans between family members, the statute (section 7872(f)(10)) limits the carry-on rule to the gift tax, and where a publication and the tax code differ, the code governs. So if a loan with a fixed end date was ever over $10,000, the gift counted on the day it was made stays counted, but once the total owed is back to $10,000 or less, no more interest is imputed for income tax. Example: a parent lends $30,000 for 3 years at 0%, and by the end of year 2 the child has paid it down to $9,000. The gift was fixed on the loan date and doesn't change; the lender's imputed interest income stops from the day the balance is $9,000. (The 1985 proposed regulation, section 1.7872-7(b)(2), reads the same way.)

The $100,000 exception (income tax only). On any day when loans between the two people total $100,000 or less, the lender's imputed interest income for the year can't be more than the borrower's net investment income (investment income, for example bank interest and dividends). If the borrower's net investment income is $1,000 or less, it is treated as zero, so the lender reports no imputed interest. This cap is for income tax only. The missing interest can still count as a gift.

Which rules apply to your loan

Total loaned between you (spouses count as one)	Lender's income tax	Gift side
$10,000 or less	Section 7872 doesn't apply (unless the money buys income-producing assets)	Section 7872 doesn't apply
$10,001 to $100,000	Imputed interest capped at the borrower's net investment income; zero if that is $1,000 or less	Forgone interest is a gift
Over $100,000	Full imputed interest at the AFR	Forgone interest is a gift

From 26 U.S.C. §7872(c)(2), (d) and (f)(7), checked 2026-09-27. Loans made mainly to avoid tax get no exception.

Imputed interest example, worked out

Example 1: $8,000 at 0%. A parent lends a grown child $8,000 interest-free for rent. The total is under $10,000 and it isn't buying investments, so section 7872 doesn't apply: no imputed interest.

Example 2: $50,000 at 0% for 3 years, made October 2026. This is a term loan (it has an end date) of 3 years or less, so the short-term AFR for October 2026 applies: 4.25% a year, locked in for the life of the loan.

Step	Amount
Forgone interest for a full year: $50,000 × 4.25%	$2,125
Lender reports, if the borrower's investment income is $300 (treated as zero)	$0
Lender reports, if the borrower's investment income is $1,500 (the smaller of $2,125 and $1,500)	$1,500
Present value today of $50,000 due in 3 years, at 4.21% compounded twice a year	$44,125.33
Gift on the loan date: $50,000 − $44,125.33	$5,874.67

Why the gift is $5,874.67 and not $2,125 a year: for a term gift loan, the gift-tax rule looks at the whole loan on day one. Getting $50,000 back in 3 years is worth less than $50,000 today. Discounted at the AFR (4.21% twice a year, the same as 4.25% yearly), it's worth $44,125.33. The difference is the value the lender gave away, counted once, on the loan date.

The $5,874.67 is under the $19,000 annual exclusion, so no gift tax return is needed, as long as the parent gives that child nothing else that pushes the year's total over $19,000.

Example 3: $150,000 at 0%. Over $100,000, so the investment-income cap is off. At 4.25%, about $6,375 a year is imputed interest income to the lender, whatever the borrower earns on investments.

October 2026 short-term AFR, IRS Revenue Ruling 2026-19. Rates change monthly.

Demand loan or term loan: which rate?

Term loan (a set end date): uses the AFR in effect on the day the loan was made, and it stays fixed.
Demand loan (the lender can ask for all of it back at any time): uses the short-term rate for each period, so the imputed interest floats as rates change. The forgone interest is a gift each year, not once on day one.

Who reports what

The lender reports imputed interest as interest income, after the exceptions above.
The borrower generally can't deduct interest on a personal loan. IRS Publication 550 says the borrower may be able to deduct the forgone interest if the money is used for business or investment. If a family loan is for a home, the borrower can deduct interest as home-mortgage interest only if the loan is a "secured debt": the borrower signs a mortgage or deed of trust on that home, it is recorded (usually with the county) under state law, the money bought, built or substantially improved that home, and the borrower itemizes deductions. A signed note alone, or one that says "secured" but is never recorded, doesn't qualify. The usual limit on home-purchase debt taken after December 15, 2017 applies: $750,000 in total ($375,000 married filing separately). A family lender won't send a Form 1098, so the borrower reports the interest as "not reported on Form 1098" on Schedule A (line 8b on the 2025 form).
The gift side: a gift tax return (Form 709) is generally needed only when one person's gifts to another total more than $19,000 in 2026, counting the forgone interest. Even then, gift tax is paid only after the giver uses up the $15 million lifetime exemption. For most families the result is a form, not a tax bill. The giver files and pays, not the borrower.

What to write in the agreement

Write down the amount, the date, the rate (even if it's 0%), and whether it's a term loan with a repayment date or a demand loan. Those facts decide which rate and which rule apply. The loan agreement generator covers them. For the rest of the setup, see how to lend money to family legally; if you're not sure it's a loan at all, read loan or gift.

Free help

Volunteer Income Tax Assistance (VITA) and Tax Counseling for the Elderly: free tax return preparation for people who generally make about $70,244 or less, people with disabilities, and limited-English speakers. They don't cover this page's topic. The IRS's guide for volunteers (Publication 4012) marks Form 709, the gift tax return, as out of scope, and imputed interest from a below-market loan isn't on its list at all; the guide's rule is that anything not listed is out of scope because volunteers aren't trained on it. A VITA site can still prepare the rest of an ordinary return.
Low Income Taxpayer Clinics: free or low-cost help if you have a dispute with the IRS, such as a notice about unreported interest, usually where less than $50,000 is in dispute. They generally serve people whose income is at or below 250% of the federal poverty guidelines: in 2026, about $39,900 for one person, $54,100 for two, $68,300 for three and $82,500 for four (higher in Alaska and Hawaii). Find one through IRS Publication 4134 or 800-829-3676.
Taxpayer Advocate Service: an independent office inside the IRS for problems you can't resolve on your own. Free. Call toll-free 877-777-4778.

Sources

Sources checked 2026-09-28.

General information, not tax advice. Rules and figures change; each figure shows where it comes from and when we checked it. Free help: IRS Volunteer Income Tax Assistance (VITA) and Low Income Taxpayer Clinics.