The same position is taken with personal, business and mortgage loans. Once again, it might be beneficial for a seller to increase his sales price and offer a low interest rate so he may profit from a lower tax liability. To prevent this from happening, the IRS requires that an applicable federal rate (AFR) be applied to all loans of six or more month’s duration. The AFR is published monthly, and determines the minimum amount of interest that should be assigned to different types of loans and investment vehicles.
If a person charges less than the AFR, the amount of interest that should have been charged is determined using the federal rate. This is the amount that the recipient will claim as income. If the interest paid qualifies as a deduction, such as a business loan or property mortgage, that is the amount the payer will show on his tax return. The difference between the actual interest and the imputed interest will be deducted from the principal of the note.
For example, if a person receives a one-year, zero interest loan of $20,000 US Dollars (USD), his loan will be adjusted for tax purposes to show both principal and interest. If the AFR for that type of loan is 10%, then the $20,000 USD repayment will be reclassified as a principal payment of $18,182 USD and an interest payment of $1818 USD. The loan would be considered paid in full, but the lender would be required to report the imputed interest as income. If the loan interest qualified as a tax deduction, the borrower would claim an $1818 USD deduction.
SO IS THE BOTTOM LINE
that the payment would be the same, and just some of it would be deemed interest and some principal?
