How to report and deduct mortgage interest on personal family loans for our first home

Thanks for the detailed response. Do the parents need to do anything special on their end to make sure this loan is viewed as a "home loan" by the IRS? Or is just having the promissory note enough? Also, can the couple still take the standard deduction or are they forced to itemize now?

The parents should make sure the loan is properly secured by the home - this typically means filing a deed of trust or mortgage document with the county recorder's office where the property is located. Just having a promissory note isn't enough; the loan needs to be secured by the property to qualify as mortgage interest. You can still choose to take the standard deduction if it's higher than your itemized deductions would be. You'll want to calculate both ways to see which gives you the greater tax benefit. With the higher standard deduction amounts in recent years, some homeowners find they're better off taking the standard deduction even with mortgage interest.

One more thing - if the home loan interest is below market rate, are there any additional tax implications for either the parents or the couple? I've heard something about imputed interest in family loans.

That's an excellent question about below-market loans. Yes, if the interest rate on the loan is below the applicable federal rate (AFR) that the IRS publishes monthly, there are additional tax implications. The IRS may "impute" interest, essentially treating the transaction as if the parents charged the minimum required interest rate even if they didn't. In a family loan situation with below-market rates, the IRS could treat the difference between the AFR and the actual rate charged as a gift from parents to children. This could potentially trigger gift tax consequences for the parents if the imputed interest exceeds the annual gift tax exclusion amount. To avoid these complications, it's best to charge an interest rate at least equal to the minimum AFR for the term of your loan. These rates are published monthly by the IRS and are relatively low compared to commercial rates.

Does this tool work for other family loan situations too? My brother loaned me money for my business and we're trying to figure out the right way to handle the interest payments.

I'm a bit skeptical about these online tools. How do you know it's giving accurate information? Did you have a tax professional review anything before filing?

Yes, it definitely works for other family loan situations! I initially found it when searching for help with our mortgage, but saw it covers all kinds of family loans including business loans. It asks specific questions about the loan purpose which helps determine the correct tax treatment. Regarding accuracy, I was skeptical at first too. What convinced me was that it cited specific IRS regulations and publications for every recommendation. I actually did have my accountant review everything before filing, and he was impressed with how thorough the documentation was. He said everything was handled correctly - the tool even caught a detail about recording the deed that my accountant hadn't initially mentioned.

How exactly does this work? Do you have to give them your personal info? Seems kinda sketchy to have a third party involved in IRS calls.

I dunno, sounds like a waste of money to me. I've gotten through to the IRS before by calling right when they open. And couldn't you just send a letter explaining the situation instead of dealing with phone calls?

You just enter your phone number on their website and what IRS department you need to reach. They use an automated system to wait in the phone queue, and when an IRS agent picks up, they connect the call to your phone. You don't share any tax details with the service - they're just getting you past the hold time. Letters to the IRS can work, but in my experience, they take months to get a response. When you're dealing with a potential audit or questions about your return, waiting that long can lead to penalties accumulating. I tried calling at opening time for two weeks straight and never got through - average wait times have been 2-3 hours lately. When you factor in the value of your time and the stress of waiting on hold, the service made sense for me.

How do you find these AFR rates? Is there a specific website? And do you have to use the exact rate or can it be higher?

You can find the AFR rates on the IRS website by searching for "Applicable Federal Rates" or "AFR" - they publish them monthly in the IRS Bulletin. The rates are divided into short-term (loans up to 3 years), mid-term (3-9 years), and long-term (over 9 years). Your rate can definitely be higher than the AFR - the AFR is just the minimum rate to avoid the imputed interest rules. Many family loans use AFR + 0.5% or something similar to make it beneficial for both parties - still lower than commercial rates but providing a decent return for the parents. Just be careful not to exceed your state's maximum legal interest rate (usury laws), which varies by state but is typically around 10-18%.

Oh that's scary! How did the IRS find out? Did they specifically ask for proof the loan was recorded with the county?