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I see a few questions on this topic, but I am more concerned with the procedure and best practices.

  1. If I give this person the money first (~$10,000), can I still have them sign a promissory note/loan agreement after the fact?

  2. How do I go about reporting this transaction to the IRS? I was thinking of an arbitrary 1% interest rate as I do not want to get penalized for offering a loan with too low of a rate.

  3. Should I get the agreement notarized at the bank? Are there any additional forms that would be helpful when I make this loan?

Thanks again for any help.

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    You can loan money or keep a friend, not both. – Raystafarian Apr 26 '16 at 16:56
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    There are too many ways this can go wrong. If you don't want to give this money to your friend as a free gift, then don't do this. – Ben Miller Apr 26 '16 at 16:59
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    thanks for the comments. I really don't want to loan the money but it is a family problem now and potentially a legal one as well so at this juncture I almost don't have a choice. @PeteBelford this is most definitely a "tale of woe" – kmk09k Apr 26 '16 at 17:39
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    @Raystafarian and sometimes you lose both. – Mindwin Apr 26 '16 at 18:32
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If this isn't a case where you would be willing to forgive the debt if they can't pay, it's a business transaction, not a friend transaction. Establish exactly what the interest rate will be, what the term of the loan is, whether periodic payments are required, how much is covered by those payments vs. being due at the end of the term as a balloon payment, whether they can make additional payments to reduce the principal early... Get it all in writing and signed by all concerned before any money changes hands. Consider having a lawyer review the language before signing.

If the loan is large enough that it might incur gift taxes, then you may want to go the extra distance to make it a real, properly documented, intra-family loan. To do this you must charge (of at least pay taxes on) at least a certain minimal interest rate, and they have to make regular payments (or you can gift them the payments but you still won't up paying tax on the interest income). In this case you definitely want a lawyer to draw up the papers, I think. There are services on the web Antioch specialize in helping to set this up properly, and which offer services such as bookkeeping and monthly billing (aT extra cost) to make it less hassle for the lender.

If the loan will be structured as a mortgage on the borrower's house -- making the interest deductible for the borrower in the US -- there are additional forms that need to be filled. The services can help with that too, for appropriate fees. Again, this probably wants experts writing the agreement, to make sure it's properly written for where you and the borrower live.

Caveat: all the above is assuming USA. Rules may be very different elsewhere.

I've done a formal intractability mortgage -- mostly to avoid gift tax -- and it wasn't too awful a hassle. Your mileage will vary.

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