Your grandson needs a car, but he cannot afford the payments. As a favor, you provide the $25,000 to purchase the car. You tell your grandson to pay you back when he can, but there is no loan document. The IRS sees this payment during an audit and asks you where your interest income is for this loan. Should this happen, you will quickly understand the meaning of AFRs.
AFRs stand for Applicable Federal Rates. They are minimum interest rates that the IRS applies to a transaction when no rate is stated or implied. In other words, you may have a transaction that the IRS believes has an interest income/expense element to it, but none has been claimed by you. These minimum interest rates are published each month by the IRS for three different loan terms: Short-term (0 to 3 years); Mid-term (4 to 9 years); and Long-term (over 9 years).
When does the AFR apply?
You may think that money you gave to a friend or that car sale to your cousin with repayment over time has no interest rate, but the IRS often sees it differently. If no interest rate is stated, the IRS will apply the applicable AFR and you could be in for a tax surprise. Here are some common examples when the AFR rates can come into play:
How to use the AFR knowledge to your advantage
Should you wish to see the published AFR rates, they are available on the IRS website at www.irs.gov AFRs.
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