imputed interest definition and meaning

gift tax

At inception, the lender purchases the bond for $7,500, and in two years’ time, they will receive a lump sum of $10,000. The tax collection agency uses the imputed interest to collect tax revenue on below-market loans and zero-coupon bonds. Because the adjusted purchase price of a zero-coupon bond is initially equal to its purchase price when issued, the accrued interest gained over each accrual period adds to the adjusted purchase price.

In theory, this interest levels the playing field from a What Is Imputed Interest? perspective, and it helps alleviate the incentives to exploit taxable income. Imputed interest is interest that a lender is assumed to have received and must report as income on their taxes regardless of whether they received it. It applies to family loans and other personal and business loans extended at no interest or an interest rate the IRS considers to be too low. The concept of imputed interest refers to the calculation of interest that should have been paid for tax calculations even if there were no actual interest payments between the lender and the borrower.

Can You Deduct Imputed Interest on Your Taxes?

AFR rates are regularly published as revenue rulings and can be looked up on the IRS website. The seller financing limit safe harbor is indexed for inflation annually. For seller-financed sale-leaseback transactions, the interest rate must be at least 110% of AFR.


You indicate that the debt instrument you will be receiving carries an adequate rate of interest which will permit you to avoid having to treat the loan as a below-market loan. However, by virtue of the debt instrument postponing all interest payments until the five-year maturity date, the loan carries OID which must be reported by you and the borrower on an annual basis. As the lender, this will create phantom income as you will be reporting each year as ordinary income the interest which is imputed without the accompanying cash payment to you to cover the tax liability. Lenders who are most commonly targeted by this law are parents, family members, and friends.

Join PRO or PRO Plus and Get Lifetime Access to Our Premium Materials

In the leasing industry, they often quote a factor versus an interest rate. However, the rate factor is based on the interest rate, the term, and the structure of the lease including payments in advance or arrears and a residual or none.

The easiest way to solve this issue is to set an interest rate that is very small and thus satisfying the demand for an interest rate put in place by the imputed interest rule. Yes, you will still pay a tax on the interest received but the amount will be minuscule in comparison with what the IRS would set in place. While it may also seem simply easier to claim the money is a gift you gave, this poses another problem that does not involve the IRS but can be far worse. If you loan money to someone but legally claim the money as a gift, there is nothing legally to keep the other party from deciding not to repay the money. In this case, any legal attempt to satisfy the loan will not be heard.

Leave a Reply