Intrafamily Loan 2026: Section 7872, AFR, Notes and Form 709

One loan, two clocks: gift tax on day one, income tax every December

Section 7872 says what happens when a lender charges too little. The statute’s definition of a gift loan is “any below-market loan where the forgoing of interest is in the nature of a gift” (7872(f)(3)). A term loan is below market when “the amount loaned exceeds the present value of all payments due under the loan” (7872(e)(1)(B)), with the present value found “by using a discount rate equal to the applicable Federal rate” (7872(f)(1)).

Two different subsections then do the work, and they run on different dates:

• Income tax, every year. For a gift loan or a demand loan, the forgone interest is treated as transferred from the lender to the borrower and “retransferred by the borrower to the lender as interest” (7872(a)(1)), on “the last day of such calendar year” (7872(a)(2)). The lender reports interest income the borrower never paid. Our reading is that this subsection applies to a term gift loan for income tax, because (a) names gift loans without limiting them to demand loans.
• Gift tax, on the loan date. For a gift loan that is a term loan, “subsection (b)(1) (and not subsection (a)) shall apply for purposes of chapter 12” (7872(d)(2)). Under (b)(1) the lender is treated as having transferred, on the date the loan was made, cash equal to the amount loaned minus the present value of the required payments.

Our applicable federal rate page quotes the same statute and works a $200,000, five-year zero-interest example. This page starts where that one stops: the paperwork, the Form 709, the borrower’s side, forgiveness and a larger loan carried through to the end.

At $300,000 the small-loan relief does not apply

The three numbers readers hear most about family loans are $10,000, $100,000 and $1,000. All three are real, and none of them helps with a $300,000 advance.

The brief version: below $100,000 the borrower’s own investment income can shrink or erase the lender’s imputed interest; at $300,000 it cannot. The cap also never applies if tax avoidance is one of the principal purposes of the interest arrangements (7872(d)(1)(B)).

Which AFR: the day the money moves

For a term loan the rate is fixed on the loan date and then stays fixed for the life of the note. That is a different rule from a sale of property, where section 1274(d)(2) uses the lowest AFR of the three calendar months ending with the month of the binding contract. We cover the sale rule on our seller financing page and our installment sale page; a seller note falls under 483 or 1274, and 7872 “shall not apply to any loan to which section 483, 643(i), or 1274 applies” (7872(f)(8)).

The tier turns on the term. Section 1274(d)(1)(A) puts “Over 3 years but not over 9 years” at the mid-term rate and “Over 9 years” at the long-term rate, so a note due on the ninth anniversary is mid-term and a note due one day later is long-term. The mid-term rate rose from 4.61% to 5.08% between October and November, so waiting a few days can be expensive: on the same $300,000, the interest-only payment at the mid-term rate is $6,840 every six months in October and $7,530 in November, which is $1,380 a year more for nine years (our arithmetic). A rate set by the loan date also lets the lender lock a rate for the full term, but demand loans work differently: for a demand loan the AFR is the short-term rate “for the period for which the amount of forgone interest is being determined” (7872(f)(2)(B)), so the rate resets as the short-term rate moves.

A $300,000 loan over nine years, four ways (our arithmetic)

The numbers below are ours, built only from the statute’s formulas and the October 2026 mid-term rate of 4.56% compounded semiannually (18 half-year periods). They illustrate the rules; they are not a computation for anyone’s return. Cases 1 to 3 assume interest-only payments with the $300,000 due at the end of year nine.

Three readings of these numbers:

• The gift on a 0% loan is the present value of the interest you did not charge. $100,065 is what nine years of $13,836 is worth on the loan date at 4.56%; the income-tax side is the same stream before discounting. Put differently, our reading is that a 0% note triggers the gift computation and the yearly imputed-interest computation together, which is the main cost of choosing 0% over the AFR.
• Case 3 is a drafting point, not a danger. The statute tests the payments against the semiannual rate. A note that states the annual rate of 4.61% and pays once a year can come out a few dollars short. Writing the semiannual rate and semiannual payments into the note, as in Case 2, removes the gap. Whether a $43 shortfall would ever be pursued is a question for the person who prepares the return.
• The loan date can add up. The same 0% loan made in November at 5.02% is a gift of $107,987.70, and a term of 9 years and one day made in October at 5.15% is a gift of $110,166.09.

The note: what the paperwork has to show

Section 7872 tests the terms of a loan; it does not decide whether an advance is a loan at all. The statute’s definition turns on whether the forgoing of interest is “in the nature of a gift,” and the surrounding facts are a matter for the preparer of the return (we have not verified court decisions on family notes, and none is cited here). What the formula does depend on is written down in the note, so a written promissory note is where the numbers come from:

• Amount and date. The amount loaned is “the amount received by the borrower” (7872(f)(4)), and the loan date fixes the AFR.
• Interest rate and compounding. Stating the rate in the form the statute uses, semiannual, avoids the Case 3 gap.
• Payment dates and maturity. The present-value test runs on the payments “required to be made under the terms of the loan” (7872(b)(1)(B)); a note whose payments are optional gives the test nothing to discount.
• Term versus demand. A note payable “at any time on the demand of the lender” is a demand loan (7872(f)(5)) and is tested year by year at the short-term rate, with no rate lock.
• Security and use of the money. These do not change the 7872 test, but they matter to the borrower. Under 163(h)(1) “no deduction shall be allowed … for personal interest,” with exceptions in (h)(2) that include qualified residence interest and interest on debt allocable to a trade or business. Whether the child can deduct any interest paid on a house loan or a business loan depends on how the loan is secured and used, not on the family relationship; that question is for the child’s preparer. If the child borrows through a company, a corporation-shareholder rule in 7872(c)(1)(C) covers below-market loans “between a corporation and any shareholder.”

If the child is young and will invest the money, the child’s investment income can also fall under the kiddie tax; the borrower’s age and income belong in the same conversation.

Form 709: who files, when, and what the loan uses up

The 2026 annual exclusion is “the first $19,000 of gifts to any person (other than gifts of future interests in property)” (Rev. Proc. 2025-32, section 4.42). The Instructions for Form 709 (2025, the current revision when we checked) say that if you gave gifts to someone totaling more than $19,000 in the year, other than to a spouse, “you must generally file Form 709,” and that the form is due “not later than April 15, of the year after the gift was made.” For a gift made in 2026 the due date is April 15, 2027. The instructions name this very case: “The gift tax may also apply to forgiving a debt, to making an interest-free or below-market interest rate loan.”

In practice:

• A gift above the exclusion is reported but usually not paid. The basic exclusion amount for 2026 is $15,000,000 (Rev. Proc. 2025-32, section 3.14), and it applies to gift tax as well as estate tax. The $81,065.24 taxable gift in Case 1 would be 0.54% of it (our arithmetic, assuming no earlier taxable gifts). Our estate tax exemption page covers the amount and the state estate taxes that start much lower.
• Gift splitting needs both spouses. The Form 709 instructions say the consent “may not be signified after April 15 following the end of the year in which the gift was made.” A married lender whose spouse consents has two $19,000 exclusions, which cuts Case 1’s taxable gift to $62,065.24.
• The exclusion needs a present interest, and we have not verified that a term loan’s below-market benefit is one. The exclusion covers gifts “other than gifts of future interests in property” (26 U.S.C. 2503(b)(1)). If the $100,065.24 did not qualify, the whole amount would be a taxable gift. Treat that as an open question for an estate attorney. Our annual gift tax exclusion page covers the exclusion and our Form 709 page covers valuation when the gift is not cash.
• Charging the AFR leaves no 7872 gift. A note at or above the AFR (Case 2) has no forgone interest, so the loan itself gives nothing to report on Form 709; the interest it pays is income to the lender under section 61(a)(4).

Forgiving the note: a second gift

Many family loans end with a decision not to collect. Under the gift tax regulation, “a taxable transfer may be effected by … the forgiving of a debt” (26 CFR 25.2511-1(a)). A note is valued for this purpose at “the amount of unpaid principal, plus accrued interest to the date of the gift, unless the donor establishes a lower value” (26 CFR 25.2512-4).

Take Case 2 and suppose the lender forgives the balance after four years of on-time interest. On our numbers:

The last row shows why nobody can quietly forgive a nine-year note inside the annual exclusion. It also hints at the risk of a plan to forgive a little each year: if the understanding at the start was that the loan would never be repaid, the advance can be looked at as a gift of the full amount on day one. We have not opened the case law on prearranged forgiveness and do not cite any; this is a facts question for an estate attorney.

On the borrower’s side, the statute excludes “the value of property acquired by gift” from gross income (26 U.S.C. 102(a)), while section 61(a)(11) lists “Income from discharge of indebtedness” as gross income. The regulation says the discharge of debt “may result in the realization of income,” for example when a creditor cancels a debt for services (26 CFR 1.61-12(a)). Which side a forgiveness falls on depends on why it was done; we do not resolve that here.

If the note is still unpaid at the lender’s death, it is property the lender owned: the gross estate includes “the value of all property to the extent of the interest therein of the decedent at the time of his death” (26 U.S.C. 2033). Forgiveness in a will is a different transaction from forgiveness during life, and the drafting is for an estate attorney.

What this page cannot tell you

• Whether your advance is a loan or a gift. A written note does not by itself settle it; the statute and the cases look at the facts, and we have not verified the case law.
• Whether the $19,000 exclusion applies to a gift measured on a term loan. The present-interest question above is open in the sources we opened.
• Your state’s rules. State law on interest rates, security interests, recording a mortgage or deed of trust, and state gift or estate taxes is outside this page.
• The 2026 Form 709. The instructions we read are the 2025 revision; the 2026 revision was not out when we checked.
• Rates for later months. The December 2026 AFR was not published when we checked. Each month’s rates come from a new revenue ruling.

What a reader can do with this

Questions to bring to a CPA or estate attorney who has the family’s documents:

1. On the day the money will move, what are the short-, mid- and long-term AFRs, and which tier does the term fall in?
2. Does the note state the rate and the payment dates in the form the present-value test uses, semiannual if that is the AFR convention?
3. If we charge less than the AFR, what is the gift on the loan date, who files Form 709 by April 15, 2027, and does the exclusion apply to it?
4. Does the lender report the interest, and can the child deduct any of it given how the loan is secured and used?
5. What is the plan if the family later decides not to collect: forgive, reduce, or leave the note to the estate?
6. How do earlier gifts to the same child count against the $15,000,000 basic exclusion amount?

This is analysis of public documents, not investment, legal or tax advice. The person who can say what a loan costs is a CPA or tax attorney with the note, the lender’s and borrower’s returns, and prior gift tax returns.

FAQ

Sources, read and saved on October 26, 2026: 26 U.S.C. 7872, 1274, 2503, 102, 61, 163 and 2033 (Legal Information Institute, Cornell Law School, text of the United States Code); 26 CFR 25.2511-1, 25.2512-4, 1.61-12 and 1.7872-5T (eCFR text via the Legal Information Institute); IRS Revenue Rulings 2026-19 (October 2026 rates) and 2026-21 (November 2026 rates) at irs.gov/pub/irs-drop; IRS Revenue Procedure 2025-32 at irs.gov/pub/irs-drop; Instructions for Form 709 (2025, the current revision on the IRS page, last updated April 30, 2026) at irs.gov/instructions/i709. Calculations marked “our arithmetic” are ours, use the October and November 2026 semiannual rates above and assume the facts stated, and are illustrations, not a computation for any return.