When parents or grandparents wish to assist the next generation with home purchases, lending the funds via an intrafamily mortgage is often financially superior to a cash gift or a commercial mortgage. It keeps the interest yield within the family ecosystem and gives the borrower access to capital at the Applicable Federal Rate (AFR), which is typically lower than commercial retail mortgage rates.
However, a common trap is failing to structure the loan so that the borrower can deduct the mortgage interest. Under IRC §163(h)(3) and Treas. Reg. §1.163-10T, for mortgage interest to be deductible as qualified residence interest, the debt must be secured debt. Under tax law, this means the loan must meet three conditions:
If a parent lends a child $500,000 to buy a primary residence and they execute only a promissory note without recording the security interest in the county registry, the loan remains unsecured. Even if the child pays interest to the parents at the long-term AFR and the parents report it as taxable interest income, the child is legally barred from claiming the interest deduction.
Furthermore, if the loan is properly secured and recorded, the lending parents must issue Form 1098 (Mortgage Interest Statement) to the child and file a copy with the IRS if the interest collected exceeds the standard reporting threshold. For families using these strategies, specialized service providers (such as National Family Mortgage) can manage the drafting, recording, and tax-reporting administration to ensure compliance with the complex state-level recording rules and federal tax laws.