Can I Loan My Child Money to Buy a House?

It is possible for parents to loan their children money for a down payment or the full price of a house. This arrangement, often called an intra-family loan, can be a beneficial way to help a child enter the housing market. However, this financial strategy is not as simple as writing a check. To ensure the transaction is recognized as a legitimate loan and not a gift, it must be structured correctly to satisfy both the Internal Revenue Service (IRS) and the child’s primary mortgage lender. Failing to follow these guidelines can lead to unintended tax consequences.

Tax Implications of a Family Loan

The IRS makes a clear distinction between a loan and a gift, and this difference is fundamental to structuring a family mortgage. The agency presumes that a transfer of money between family members is a gift unless there is clear evidence to the contrary. For the transaction to be treated as a loan, it must have the characteristics of an arm’s-length agreement, including a formal written document, a set repayment schedule, and a minimum interest rate.

A requirement for a family loan is charging an adequate interest rate. The IRS publishes a set of minimum rates each month known as the Applicable Federal Rates (AFRs). These rates are based on the average market yields of U.S. Treasury securities and are categorized by the loan’s duration: short-term (three years or less), mid-term (more than three but not more than nine years), and long-term (more than nine years). The interest rate on the family loan must be at least the AFR in effect for the month the loan is made.

If the loan’s interest rate is below the appropriate AFR, the IRS can invoke the “imputed interest” rule. Under this rule, the IRS calculates the difference between the interest that should have been collected using the AFR and the interest that was actually paid. This difference is considered a “foregone interest” amount, and the parent must report this imputed interest as taxable income, even though they never actually received the money.

The IRS provides an exception for loans of $100,000 or less. Under this rule, the amount of imputed interest the parent must report as income is limited to the child’s net investment income for the year. If the child’s net investment income is $1,000 or less, the imputed interest is considered to be zero, and the parent has no additional taxable income from the loan.

This foregone interest is simultaneously treated as a gift from the parent to the child. For 2025, individuals can give up to $19,000 to any person without gift tax consequences under the annual exclusion. If the imputed interest amount exceeds this annual exclusion, the parent must file a gift tax return (Form 709), and the excess amount reduces the parent’s lifetime gift tax exemption, which for 2025 is $13.99 million per individual.

Creating the Formal Loan Documents

The primary document for a family loan is the promissory note, which serves as legal evidence of the debt. This document must include the full legal names of the lender and borrower, the principal amount of the loan, and the date the agreement is made. The promissory note must also specify the interest rate and a detailed repayment schedule showing the frequency and amount of each payment, and the total term of the loan. The note should be signed and dated by all parties involved to be considered a valid contract.

Beyond the promissory note, it is highly advisable to secure the loan with a mortgage or deed of trust. This legal document is filed with the county recorder’s office and attaches the loan to the property as a lien. If the child defaults on the loan or sells the property, the recorded lien ensures the parent is in a position to be repaid from the proceeds.

The mortgage or deed of trust contains the property’s legal description, the loan amount, and references the terms of the promissory note. Recording this document creates a public record of the debt, which is a step that primary mortgage lenders often require. This formalizes the parent’s position as a lienholder on the property, similar to a traditional bank.

Coordinating with the Primary Mortgage Lender

When a child is also obtaining a traditional mortgage from a financial institution, the family loan must be disclosed and properly integrated into the overall financing. The primary lender will view the funds from the family loan as part of the child’s assets for the purchase, but they will also consider the associated monthly payment as a new debt obligation.

The primary lender will require a copy of the fully executed promissory note to verify the terms of the family loan. This is used to confirm that the family loan is a legitimate debt and not an undocumented gift that could be recalled, which would pose a risk to the lender.

The monthly payment from the family loan will be included in the calculation of the child’s debt-to-income (DTI) ratio. The DTI ratio compares a borrower’s total monthly debt payments to their gross monthly income and is a major factor in mortgage approval. A higher DTI can make it more difficult to qualify for the primary mortgage, so it is important to understand how the new payment will affect this calculation before finalizing the family loan terms. The lender will also require a copy of the recorded mortgage or deed of trust to confirm that the family loan is properly secured against the property.

Annual Reporting and Loan Administration

Once the loan is active, both the parent and child have ongoing responsibilities for tax reporting. For the parent acting as the lender, the interest received from the child is considered taxable income. This amount must be reported on the parent’s annual federal income tax return on Schedule B (Form 1040), listing the child’s name as the payer and the total amount of interest received during the tax year.

For the child acting as the borrower, the interest paid on the family loan may be tax-deductible, just like interest paid to a traditional mortgage lender. To qualify for the mortgage interest deduction, the loan must be secured by the home. If the loan is secured, the child can generally deduct the interest paid on their Schedule A (Form 1040), subject to the same limitations as other mortgage interest.

In some cases, the parent may be required to issue an IRS Form 1098, Mortgage Interest Statement, to the child. This form reports the amount of mortgage interest the child paid during the year. An individual lender is required to issue a Form 1098 if they are engaged in a trade or business of lending money. While a single family loan does not meet this definition, providing the form can be a helpful practice for clear record-keeping and to support the child’s mortgage interest deduction.