A family loan is a personal loan made to a family member. The degree of relationship doesn’t really matter, and these loans are undoubtedly common. Over $60 billion US Dollars (USD) per year is loaned to family from family. Despite the common nature of family loans, people should be aware of some of the implications of these loans both in continuing healthy family relationships and in potential tax ramifications.

It can be difficult to give a family loan if you don’t fully define the terms of repayment, and some people recommend that you always consider the money a gift. When family members don’t repay loans, they may cause great strain in relationships. If the lender considers the money lost at the onset, this may help reduce potential conflict later. It’s also advised that you not lend money to anyone unless you can afford to lose it. Unlike a bank, you don’t have any type of loan insurance that will return the money to you if a relative doesn’t pay it back.

People seeking a loan from a family member should be reasonably certain that they can stick to a payment plan and an agreed upon payment amount. If you think you won’t be able to meet your obligations, you may want to ask for a gift instead, or not borrow the money. In some ways, any borrower of a family loan should not consider this money as coming from family. Some people are more likely to fail to repay loans that come from family, unless they sign a contract and believe they will be sued if they don’t repay.

This brings up an important issue. Family loans tend to work better when lender and borrower actually sign a contract specifying terms and consequences if money remains unpaid. There are sample contracts online that you can download. Making the terms of the family loan extremely clear can help avoid misunderstandings along the way.

In the US, if you loan less that $10,000 US Dollars (USD), you don’t have any tax obligations, and there are certainly many people who make small loans to family. You can make this amount of a “gift” per year without paying gift taxes and provided you don’t collect interest, you’re not making income if the loan is repaid. If you do charge interest on this smaller amount, this is technically taxable income and needs to be claimed on tax returns.

When a family loan exceeds $10,000 USD, the situation can become murky. To avoid paying a gift tax, people need to claim money loaned, but the IRS may assign you an interest rate that they expect you to collect as “income.” To avoid this, it helps to consult a good tax attorney or accountant to make sure the terms of the loan are clear, especially if no interest is being charged.

Another thing that may help in claiming this money as a loan is that you can claim unpaid amounts which will never be paid, as a tax loss. However, sometimes the IRS will try to collect taxes from the borrower if the money technically becomes a gift due to nonpayment. This may be a more reasonable step than having to sue a family member, but it’s still a little complicated and may be best managed by a tax professional.

It’s advised that family members think carefully before issuing or borrowing family loans. Even formerly excellent relationships can be soured if a loan is unpaid, and sometimes people who borrow money feel frustrated by closer scrutiny of their financial dealings by their family lenders. These loans may be a way to obtain interest free funds, but there can be hidden relationship costs. It’s also wise for participants to understand potential tax obligations of creating or accepting a family loan or a gift.