Updated August 3, 2026. Quick answer: for most ordinary family loans nothing is imputed and nothing is taxed — but that is because of a specific provision most summaries skip, not because the rules do not apply. The two things that matter are whether the loan is genuinely a loan, and whether the borrower has investment income.
What the law actually does
Section 7872 treats a below-market loan as though it were made at a market rate. In the statute’s own words, “the forgone interest shall be treated as transferred from the lender to the borrower, and retransferred by the borrower to the lender as interest.”
Leg one: the forgone interest is treated as transferred from lender to borrower – for a family loan that leg is a gift. Leg two: the same amount is treated as retransferred by the borrower back to the lender as interest, which the lender must report as interest income.
So on paper the lender has interest income they never received, and the borrower has received a gift they never saw. That is the machinery. The exceptions are what usually stop it from biting.
The first exception: under $10,000
“this section shall not apply to any day on which the aggregate outstanding amount of loans between such individuals does not exceed $10,000.”
With one carve-out: “Subparagraph (A) shall not apply to any gift loan directly attributable to the purchase or carrying of income-producing assets.” — so a loan used to buy investments does not get this exception.
The second exception, and the sentence that decides most family loans
Above $10,000 there is a further rule: “the amount treated as retransferred by the borrower to the lender as of the close of any year shall not exceed the borrower’s net investment income for such year.”
This does NOT exempt loans up to $100,000 from imputation. It CAPS the imputed interest at the borrower’s net investment income for the year. The $100,000 figure is the aggregate-outstanding ceiling above which the cap stops applying at all.
And then this, which is the provision worth knowing:
If the net investment income of any borrower for any year does not exceed $1,000, the net investment income of such borrower for such year shall be treated as zero.
Where the borrower’s net investment income for the year is $1,000 or less, the cap becomes ZERO – so no forgone interest is imputed to either party for that year at all. Not merely capped low: nothing.
This is the provision most summaries omit or garble, and it is the one that decides whether an ordinary family loan produces any tax consequence at all. A borrower with little or no investment income and a loan under the $100,000 ceiling typically has nothing imputed. How the cap works in detail.
One condition disables it: “Subparagraph (A) shall not apply to any loan the interest arrangements of which have as 1 of their principal purposes the avoidance of any Federal tax.”
Both thresholds are tested daily, and they aggregate
Both thresholds are tested on the AGGREGATE outstanding balance between the same two people, and tested DAILY – the statute says ‘any day on which the aggregate outstanding amount of loans between such individuals’ exceeds the figure.
That matters more than it sounds. Three separate $4,000 loans to the same child are one $12,000 relationship for this purpose, and lending more before the first is repaid can push you over a line you did not know you were near.
The question underneath all of it
None of the above applies unless there is actually a loan. The regulation defines it: “A bona fide debt is a debt which arises from a debtor-creditor relationship based upon a valid and enforceable obligation to pay a fixed or determinable sum of money” And plainly: “A gift or contribution to capital shall not be considered a debt for purposes of section 166.”
The verified legal question is binary and comes from the regulation itself: was there a genuine, legally enforceable obligation to repay a sum certain, or was it a gratuitous transfer? Publish that standard, and present the practical documentation points as what makes an obligation provable and enforceable – not as an IRS checklist. What makes the difference in practice.
What to do
- Decide honestly whether it is a loan or a gift. Both are fine. Pretending is what causes trouble.
- If it is a loan, charge at least the applicable federal rate and take it off the table entirely. Where the rate comes from.
- Write it down. A signed note with principal, rate and a repayment schedule is what makes the obligation enforceable and provable.
- Keep the records — the payments actually made, in a form somebody else could follow years later.
- Think about what happens if you die holding it. The note is an estate asset, and everyone can see it.
If you are going to do it, write it down
The regulation’s own test is whether there was a valid and enforceable obligation to repay a sum certain. A signed promissory note stating principal, rate and repayment schedule is what makes that provable — and it protects both generations, not just the lender. LawDepot builds a state-specific promissory note. For a large or complex arrangement, see a lawyer.
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General information drawn from IRS, Medicare, HUD and state statute and regulation, not legal, tax or financial advice. Continuing-care law is state law and differs materially between states; every figure here is year-labelled and every source named. Powers of attorney, guardianship and trusts are governed by STATE law and differ change, and interest rates published by the IRS change every month – never rely on a rate quoted on any page, including this one. We are not a law firm or a tax adviser, and this is not legal or tax advice.