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Area I: Individual Compliance and PlanningTCPImputed InterestIndividual Tax

CPA · Question 02 · Area I: Individual Compliance and Planning

A taxpayer provides an interest-free loan of $200,000 to their adult child on January 1, Year 1, to purchase a primary residence. The loan is payable on demand. The applicable federal rate (AFR) for Year 1 is 4%. The child has net investment income of $800 for Year 1. Assuming the gift tax annual exclusion is $18,000, what are the income tax implications for the lender (parent) regarding imputed interest?

Answer options:

A.

The lender must recognize $8,000 of interest income.

B.

The lender recognizes $0 interest income because the loan is under $100,000.

C.

The lender recognizes $8,000 of interest income.

D.

The lender recognizes $800 of interest income.

How to approach this question

Check loan amount first. If > $100,000, full AFR applies. If <= $100,000, interest is limited to borrower's net investment income (or $0 if NII <= $1,000).

Full Answer

C.The lender recognizes $8,000 of interest income.✓ Correct
Under IRC §7872, for gift loans exceeding $100,000, the foregone interest is treated as transferred from the lender to the borrower (gift) and retransferred from the borrower to the lender (interest income). The amount is $200,000 * 4% = $8,000. The limitation based on net investment income (IRC §7872(d)) applies only to loans of $100,000 or less.

Common mistakes

Applying the $100,000 exception rules to a loan that exceeds that threshold.
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