The Family Bank: Parents Are Lending Their Kids Mortgage Money at Rates the IRS Itself Publishes, and No One Owes Gift Tax on the Discount.
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If you own a home with equity, a taxable brokerage account, or a bond ladder that your adult kid cannot afford to touch, the IRS quietly publishes a mortgage rate every month that only your family can actually use. It is called the Applicable Federal Rate, and lending your child a down payment or even a full house purchase at that rate is a mechanism the tax code explicitly sanctions. The gap between the AFR and a real 30-year mortgage also counts as zero for gift-tax purposes, which means no one owes the IRS anything on that discount.
Rate the IRS Prints and Your Bank Won’t Match
The IRS releases new short-term, mid-term, and long-term rates every month. If you lend your child money for a home at or above whatever the applicable rate happens to be, the tax code treats it as a bona fide loan rather than a gift in disguise. For August 2026, the long-term AFR, which covers any loan longer than nine years and includes all standard mortgages, is 4.92% with annual compounding.
The mid-term rate for notes lasting three to nine years is 4.35%. By comparison, the 10-year Treasury was yielding 4.74% on August 21, 2026, and that is the benchmark most retail mortgages use as their starting point before adding a lender spread.
Code Section Doing the Work
The legal machinery is Internal Revenue Code Section 7872, which governs below-market loans, paired with Section 1274(d), which requires the IRS to publish AFRs monthly. The current month’s rates come from Revenue Ruling 2026-13. A note charging at least the AFR in effect in the month the loan is made, with the rate locked for the life of the loan, falls outside Section 7872. When the rate charged is lower, the foregone interest is imputed to the parent as income and treated as a gift to the child.
Who This Actually Fits
This approach works best for parents with liquid assets earning less than the AFR, a fully paid or lightly mortgaged home they can borrow against, or cash sitting in Treasuries. It falls apart, though, if the parent actually needs that principal for retirement income, if the child realistically cannot make the payments, or if siblings will view a soft loan as blatant favoritism. It is also a poor fit for parents whose only real asset is a retirement account, because pulling from a 401(k) or traditional IRA triggers taxes that would completely swamp any savings from the AFR.
Mechanics That Keep the IRS Away
- The correct AFR applies to the term. A 30-year note uses the long-term rate: 4.92% for August 2026. A 9-year balloon uses the mid-term rate.
- A written promissory note documents the principal, interest rate, payment schedule, and maturity date. A verbal handshake gets treated as a gift.
- The note is secured by a recorded mortgage or deed of trust against the home. Without a recorded lien, the child cannot deduct the interest as qualified residence interest.
- Monthly payments run through an automated transfer to create a paper trail. Missed payments look like forgiveness, which looks like a gift.
- Interest received is reported on Schedule B of Form 1040. It’s ordinary income to the parent.
- The $19,000 per-recipient annual gift-tax exclusion for 2026 can be applied to forgive part of the note each year to accelerate the transfer. Married parents can jointly exclude $38,000 per child.
Where Families Trip the Wire
The catch is the taxable-income side. Every dollar of AFR interest the child pays is ordinary income to the parent, taxed at the marginal rate, and there’s no offsetting deduction unless the loan is secured and the child itemizes. Without a recorded lien, the child loses the mortgage-interest deduction entirely. There is a $10,000 de minimis exception under Section 7872(c)(2) for gift loans between individuals, but any mortgage-sized loan blows through it instantly.
Section 7872 also has a special rule capping imputed interest at the borrower’s net investment income for loans of $100,000 or less, which does not help with a typical home purchase. And the rate is locked when the note is signed, so a note written in August 2026 stays at 4.92% even if AFRs fall next year, absent a formal refinance and re-documentation. Existing home sales are running at an annualized 4.06 million as of July 2026, and the Case-Shiller index sat at 335.1 in May 2026, so affordability math is why families keep reaching for this tool.
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