Can I make my loan from a family member official enough to deduct the interest?

Factual Questions
1

It’s my understanding that to deduct interest from paying a loan, the borrower has to be legally obligated to pay back the loan in order for the interest to be tax deductable.
Cite: http://moneycentral.msn.com/articles/tax/reduce/1387.asp

My Dad and I are considering me taking a loan from him at an interest rate much lower than what I’m paying the bank for my mortgage, but still higher than what he’s generally getting from his investments. This will help me quite a bit because I’m unemployed, and will be advantageous to him as well.

Now, is there a way to make this loan official enough such that I’m legally obligated to pay it back, a “true debtor-creditor relationship”, so that I can deduct the interest? It would still be worth it otherwise, but every little bit helps.

2

I’m in Australia so take this with caution, but over here at least it is certainly possible to make a family loan sufficiently “official” enough that you can deduct interest. Make sure that the interest rate is commercially viable (which does not mean it has to be as high as a standard rate, but does mean it is more than token). Document the loan properly with a written agreement containing all the usual hard nosed commercial terms. Conduct the loan properly with regular payments that you can prove (ie through bank accounts, not just undocumented cash). Have proper written accounts showing interest accruing. Perhaps put specific terms in the loan documentation stating that despite the family relationship, you both agree to be legally bound by the deal.

Subject to your local law, it should be possible. YMMV

3

You could write a loan agreement and execute it. Be aware that the IRS has established minimum interest rates that must be charged.

And, if you establish the true debtor-creditor relationship and fail to pay back the loan, or if the creditor forgives repayment, you may be liable for income tax on the proceeds of the loan. Also, the creditor must pay income tax on the interest accrued on the loan, whether received or not, at least until it is in default.

I guess I should’ve said at the outset that IANAA or an L, but the above is based on my CPA’s advice regarding several loans my companies made to officers over the years.

4

Thanks for the leads guys!

5

Don’t forget to have dad declare the interest as income otherwise he is breaking the law.

6

Don’t forget to have dad declare the interest as income otherwise he is breaking the law.