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My uncle gave me a zero-interest 70k loan. I immediately used it to pay off a big chunk of my student loans. As I understand, under the 100k rule he doesn't owe any tax on imputed interest as long as my investment income is <1k. So for a few years we didn't report anything. But this year I'm finally hitting that limit, between bank interest and capital gains from some mutual funds I've invested in.

Questions:

  • Does the fact that I used the loan to pay off a student loan affect things?
  • I drew it up as a "demand" loan - so that means he only has to pay taxes based on the short-term AFR, right? So for 2014 that was about 0.34%, so the income is only $238. But it's supposed to be compounded semi-anually. Did I do that correctly?
  • What sort of document should I send to my uncle indicating how much he owes in taxes? I'd like it to be good in case the IRS ever looks.

Thanks so much...

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    What country are you talking about? What's the 100k rule you're referring to? – littleadv Dec 26 '14 at 20:10
  • USA. Some more info about below-market rules here: thismatter.com/money/tax/imputed-interest.htm – cgreen Dec 26 '14 at 20:13
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    @cgreen The link you refer to says "Imputed interest rules also do not apply to: gift loans of $10,000 or less (aka de minimis loans), unless it is used to purchase income producing property, in which case, the following $100,000 rule applies. loans of $100,000 or less. If the loan is used to purchase investment property, then imputed interest rules do not apply if the net investment income from the property does not exceed $1,000." I have added emphasis to point out the parts that you are ignoring. You did not buy property and you are not getting net investment income. – Dilip Sarwate Dec 26 '14 at 20:58
  • @DilipSarwate I think you misread this. – littleadv Dec 26 '14 at 21:22
  • Yeah I'm pretty sure the 1000 threshold is for net investment income, which isn't just property income. Though it's hard to find exactly what that means. – cgreen Dec 26 '14 at 21:27
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The rule in question is imposed by the IRC Sec. 7872. You would probably be better off with a professional tax adviser (EA/CPA licensed in your State), but this is how I read it:

  1. If the loan is less than $10K - don't worry about it, no-one cares, unless you used it to buy an income-producing property (not your case).

  2. If the loan is less than $100K and you don't have net investment income (see the note below) - don't worry about it, no imputed interest is calculated. This may be your case, depending on your investments. Note, I disagree with Dilip on the interpretation of this part: the investment income, IMHO, is your total investment income, regardless of the income-producing property (if any) you purchased using this loan. This rule is to avoid shifting income from higher brackets to lower brackets.

  3. If there's net investment income - the lower of the net investment income or the calculated imputed interest is accounted as interest. This is codified in Sec. 7872(d)1.A.

  4. If the loan is above $100K - calculate imputed interest and it all is accounted.

  5. If there's imputed interest - it is considered a gift, and if it exceeds $14K (together with all the other gifts from that person to you during the year) - gift tax applies and gift tax return should be filed.

All the accounted interest should appear on your uncle's Schedule B as income to him.

Note: the amounts are aggregate, not per loan. I.e.: if your uncle gave you $70K now, but another $31K last year - the amount in question is not $70K, it is $101K.

Another note: if your net investment income is less than $1000, then it is considered to be $0 (as you mentioned in your answer). This is called "de minimis rule", and is codified in Sec. 7872(d)1.E(ii).


To answer your specific questions, as it seems you've got the Sec. 7872 conditions right:

Does the fact that I used the loan to pay off a student loan affect things?

No.

I drew it up as a "demand" loan - so that means he only has to pay taxes based on the short-term AFR, right? So for 2014 that was about 0.34%, so the income is only $238. But it's supposed to be compounded semi-anually. Did I do that correctly?

Yes.

What sort of document should I send to my uncle indicating how much he owes in taxes? I'd like it to be good in case the IRS ever looks.

Write him an email saying "dear uncle, my investment income this year exceeds $1000 limit, so you're on the hook for the imputed interest. Sorry, your loving nephew".

  • littleadv, To me, the sentence "If the loan is used to purchase investment property, then imputed interest rules do not apply if the net investment income from the property does not exceed $1,000." seems to say that there is no problem as long as the net investment income from the property purchased with the loan proceeds does not exceed $1K. Regardless of the meaning of that the that I have put in boldface, I wonder if paying off student loans counts as investing in property. – Dilip Sarwate Dec 26 '14 at 22:06
  • This is great. Thanks so much. I've read so many takes on this rule and it all seems so informal. – cgreen Dec 26 '14 at 22:19
  • @DilipSarwate I didn't read the article, but I did go through the statute. Can you tell me where in the statute it says so? – littleadv Dec 26 '14 at 22:22
  • @littleadv - The code says I have to compound semi-annually. But looking at the AFR (which was 0.25% for January this year and 0.36% for August) I can't find out whether it's supposed to be an annual rate or a semi-annual rate. I.e., is the rate 0.25% for the whole year (=175) or 0.25%+0.36% (=252)? Man this stuff is nuts. – cgreen Dec 27 '14 at 7:14
  • @cgreen you compound semi-anually, but the rate is always annual. – littleadv Dec 27 '14 at 7:16

protected by Community Nov 4 '17 at 19:31

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