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How does the IRS distinguish between the two? Is it that if you have back-up proof of the loan then it is a loan repayment and not a gift. This is between family members, of course. Also if there is a repayment of interest should that be documented at the time of the loan (will it be considered a gift [and subject to gift tax] otherwise?)

I think what you are referring to is called a Gift Loan by the IRS but I think the max is 100K.

First, make sure the paperwork supports the loan. A loan agreement signed between both parties should support the fact that its a loan and not a gift.

Secondly, if its your intent is to make an interest free loan to say you son/daughter then the issue is how do you avoid the IRS's minimum interest rate issue. By making annual gifts of the forgiven interest each year you should avoid the IRS's minimum interest rate problem - could work as long as the forgiven interest doesn't exceed the 10K per year minimum.

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