John Bullis: Understanding, using applicable federal rates
July 10, 2012
“AFRs” is short for Applicable Federal Rates. The Internal Revenue Service determines on a monthly basis the federal short-term, mid-term and long-term interest rates. The federal short-term interest rate is for written debts or loans that mature in less than three years.
The federal mid-term interest rate is for debts or loans that mature in three years, but not over nine years. The long-term interest is for debts or loans that mature in over nine years.
For a sale or exchange, the applicable federal rate of interest that applies for any month in the three-calendar-month period ending with the first calendar month in which there is a binding written contract.
The July AFRs are:
• 0.24 percent for short-term loans (not over three years)
• 0.92 percent for mid-term loans (over three years but not over nine years)
• 2.30 percent for long-term loans (over nine years).
These historically low interest rates can be a benefit in certain situations.
Suppose the older generation (parents, etc.) sell their home to a child or others and wants to “carry the paper” at the lowest interest rate possible. They don’t want to charge any interest, but understand for tax purposes, they must charge at least the applicable interest rate.
If the loan matures (must be paid off or refinanced) 8 1/2 years after the sale, they could use the 0.92 percent interest rate if the sale is done in July of this year.
The parents would recognize and be taxed on interest income, but not much. That’s a way to transfer a benefit to the buyer that is not a gift for tax purposes.
Like all tax rules, there is a general rule and then a lot of exceptions for special situations.
For transfers (sales) of land between family members, the rate will not exceed 6 percent, compounded semiannually. That rule applies only if the total sales price of all prior land sales between family members during the calendar year does not exceed $500,000.
However, that limit on the rate does not apply if any party to the sale is a nonresident alien (not a U.S. citizen who does not reside in U.S.).
If you want to charge a very low interest rate on a sale, look into the use of AFRs.
Did you hear: “There are two kinds of people who don’t say much … those who are quiet and those who talk a lot.”
• John Bullis is a certified public accountant, personal financial specialist and certified senior adviser serving Carson City for 45 years. He is founder emeritus of Bullis and Company CPAs, LLC.