Can I Borrow Money From My Company to Buy a House?

It is possible for an individual to borrow money from their own company, such as a closely held business, S-Corp, C-Corp, or an LLC taxed as a corporation, to finance a personal purchase like a house. This arrangement offers flexibility, but requires careful structuring to avoid significant adverse tax consequences for both the borrower and the company. The Internal Revenue Service (IRS) scrutinizes these transactions to ensure they are legitimate loans and not disguised distributions of profits or compensation.

Structuring a Legitimate Company Loan

Establishing a company loan as a bona fide debt in the eyes of the IRS is paramount, distinguishing it from disguised compensation or a dividend. The intent for repayment must be clear and supported by objective evidence. Without proper structuring, the IRS may reclassify the transaction, leading to unintended tax liabilities.

A formal, written promissory note is a fundamental requirement for any legitimate loan. This document legally binds the borrower to repay the funds and outlines the specific terms of the agreement. It should detail the loan amount, the interest rate, and the repayment schedule, providing a clear and enforceable promise to repay.

The loan must include a stated interest rate at least equal to the Applicable Federal Rate (AFR). The IRS publishes AFRs monthly as minimum interest rates for loans between related parties, preventing tax avoidance. These rates vary by loan term: short-term (up to three years), mid-term (over three but not more than nine years), and long-term (over nine years). Using the appropriate AFR ensures compliance and prevents the IRS from imputing interest.

A fixed and reasonable repayment schedule is also essential, demonstrating a genuine expectation of repayment. This schedule should not be contingent on the company’s profitability or the borrower’s discretion. Consistent, actual repayments are crucial evidence that the transaction is indeed a true loan, and any deviation or missed payments could trigger IRS scrutiny.

Securing the loan with collateral, such as a mortgage on the purchased house, can strengthen its legitimacy. Collateral provides the company a means of recovery if the borrower defaults, indicating a bona fide debtor-creditor relationship. The loan terms should clearly delineate it as a formal debt, not a salary advance, bonus, or dividend, by adhering to standard loan conditions.

Tax Implications for the Borrower

The tax consequences for the borrower depend on whether the IRS treats the transaction as a legitimate loan or recharacterizes it. If legitimate, principal repayments are not tax-deductible, and the loan itself is not taxable income, as it’s a temporary transfer of funds. Interest paid to the company may be deductible as qualified residence interest if secured by the home, or as investment interest if used for investment purposes, subject to limitations.

If the IRS recharacterizes the loan as compensation, the entire amount (or a portion of it) becomes taxable income to the borrower. This reclassification means the funds are viewed as wages, subjecting them to federal income tax and potentially payroll taxes, such as Social Security and Medicare taxes. Such a recharacterization can lead to a significant unexpected tax burden for the individual, as they would be taxed on funds they intended to repay.

Alternatively, the loan might be recharacterized as a dividend, especially for C-corporations or if S-corporation distributions exceed the shareholder’s basis. If deemed a dividend, the amount becomes taxable income to the borrower. For C-corporations, these are often qualified dividends, taxed at capital gains rates. For S-corporations, they may be taxed as ordinary income. Unlike compensation, dividends are generally not subject to payroll taxes.

If the interest rate charged is below the Applicable Federal Rate (AFR), the IRS may impute interest. This means the difference between the AFR and the rate charged is treated as if paid to the borrower and then returned to the company. This “imputed interest” can be additional taxable income to the borrower, even without cash changing hands, depending on whether the loan is compensation-related or a dividend. This rule prevents related-party transactions from circumventing tax obligations.

Tax Implications for the Company

When a company provides a loan to an owner or employee, the tax implications for the company vary significantly based on how the IRS views the transaction. If the loan is treated as a legitimate, bona fide loan, the company records the disbursed funds as a loan receivable, which is an asset on its balance sheet. Any interest received from the borrower is considered taxable income to the company, increasing its overall taxable earnings. Conversely, the principal repayments received are not considered taxable income to the company, as they represent a return of capital, not new revenue.

Should the IRS reclassify the loan as compensation, the company may be able to deduct the reclassified amount as a business expense, similar to salary or bonus payments. This deduction can reduce the company’s taxable income, provided the amount is considered reasonable compensation for services rendered. However, this reclassification also triggers additional payroll tax obligations for the company, as it must pay the employer’s share of Social Security and Medicare taxes on the reclassified compensation.

If the loan is recharacterized as a dividend, especially for C-corporations, it is generally not deductible by the company. This means the company cannot reduce its taxable income by the dividend amount. This can result in “double taxation” for C-corporations, where the company pays tax on profits, and the shareholder pays tax again on the dividend. For S-corporations, a reclassified dividend reduces the company’s accumulated adjustments account (AAA) or retained earnings, but does not create a tax deduction.

If the company charges an interest rate below the AFR, the IRS may impute interest income to the company. This means the company is treated as if it received the interest that should have been charged at the AFR, increasing its taxable income. While this creates a taxable income item for the company, in closely held entities, the corresponding imputed interest income for the company and imputed interest expense for the borrower may sometimes result in a wash from an overall tax perspective, though reporting requirements remain.

Corporate Governance and Documentation

Formal corporate procedures and ongoing documentation are essential to substantiate the legitimacy of a company loan and ensure regulatory compliance. Documenting the loan process helps to demonstrate that the transaction is at arm’s length, similar to a loan made to an unrelated third party. This meticulous record-keeping is a primary defense against IRS recharacterization.

Formal board of directors’ approval, or member/manager approval for LLCs, should be clearly documented in corporate minutes. These minutes should specify the purpose of the loan, the terms and conditions, the interest rate, and the repayment schedule. This official corporate action provides evidence that the loan was a deliberate business decision, not an arbitrary withdrawal of funds.

For companies with multiple owners, shareholder agreements may need to address related-party loans explicitly. Such agreements can set parameters or require specific approvals for loans to shareholders, helping to manage expectations and potential conflicts of interest among owners. This proactive approach ensures transparency and fairness within the corporate structure.

Accurate and consistent recording of the loan and all repayments in the company’s financial books is indispensable. The loan should be clearly identified as a “loan receivable from officer/shareholder” on the company’s balance sheet, and interest income recorded appropriately. Maintaining detailed ledgers and providing annual statements, such as Form 1099-INT for interest paid, reinforces the loan’s authenticity.

Strict separation between company and personal finances is paramount to maintain the loan’s integrity and avoid commingling, which can undermine legitimacy. Periodic review of loan terms and repayment status is also advisable to ensure ongoing compliance.