The Applicable Federal Rate (AFR) is the interest rate the IRS uses as a floor for loans between family members and other related parties. If you lend money at a rate below the AFR, the IRS can treat the difference as a gift from lender to borrower — which can have tax consequences for both parties.
The AFR is published monthly by the IRS and varies based on the loan duration.
Why the IRS created the AFR
Without a minimum rate requirement, family members could use low-interest or no-interest loans as an indirect way to transfer wealth — effectively circumventing gift tax rules. The AFR closes that loophole by requiring that loans charge at least a market-equivalent rate. Any interest "foregone" by charging below the AFR is treated as if it were given as a gift.
This rule applies to loans between related parties — which the IRS defines broadly to include family members, corporations controlled by the lender, and certain trusts.
The three AFR tiers
The AFR is divided into three tiers based on the loan term:
| Tier | Loan duration | 2026 range (January to October) |
|---|---|---|
| Short-term | 3 years or less | 3.56% to 4.25% |
| Mid-term | Over 3, up to 9 years | 3.81% to 4.61% |
| Long-term | More than 9 years | 4.62% to 5.22% |
Rates change every month and are tied to Treasury yields. In a normal yield curve the long-term rate is the highest of the three, as it has been all through 2026. When the curve inverts, the short-term rate can end up on top.
The IRS publishes the exact rates each month in a Revenue Ruling (typically around the 20th of the preceding month). Current and historical rates are listed at IRS.gov/applicable-federal-rates.
How the AFR applies to family loans
To stay outside the below-market loan rules, a loan generally needs a rate of at least the AFR in effect when the loan was made. For a term loan (one with a fixed repayment schedule), that means the AFR for the loan's term, for the month the loan is made. Once a term loan is made at or above that rate, it stays above the floor for its whole term: you don't need to update it every month, even if the AFR rises later.
Which month's AFR applies?
This is where families most often get caught out. The IRS publishes each month's rates around the 20th of the month before, so a note drafted in one month and signed in a later one can face a different AFR than the one it was written around. If rates rose in between, a rate that was above the AFR when the note was drafted can be below it by the time the loan is made. In 2026, for example, the long-term AFR went from 4.92% in August to 5.12% in September and 5.22% in October.
Which date counts as the day the loan was made (the signing date, the date the money moved, or something else) depends on the facts, and is a question for the attorney or tax professional who drafted the note.
Demand loans, which the lender can call in at any time, work differently: they are measured against the short-term AFR as it changes, and the IRS publishes a blended annual rate each July for demand loans outstanding the whole year.
A few important thresholds:
Loans of $10,000 or less: The imputed interest rules generally do not apply. You can charge 0% on very small loans without IRS complications (with some limitations).
Loans between $10,001 and $100,000: Imputed interest rules apply, but the interest the lender is taxed on is capped at the borrower's net investment income for the year, and treated as zero if that income is $1,000 or less. The cap covers the income tax side only, not the gift side, and it does not apply if avoiding tax is one of the main purposes of the loan.
Loans over $100,000: Full imputed interest rules apply with no investment-income cap.
What happens if you charge below the AFR
If your interest rate is below the AFR, the IRS treats the "foregone interest" — the difference between what you charged and what the AFR requires — as if it flowed through two transactions simultaneously:
- The lender gives the foregone interest to the borrower as a gift. This counts against the lender's annual gift tax exclusion and, if it exceeds the exclusion, may require filing Form 709.
- The lender is treated as if they received that interest as income. Even though the cash never changed hands, the lender may owe income tax on it.
In practice, for loans below $100,000 where the borrower has modest investment income, the amounts involved are often small enough that the practical impact is limited. But for larger loans, the difference between charging 0% and charging the current AFR can be significant.
If your note is already signed below the AFR
Section 7872 deals with the interest: it is the shortfall, the gap between the rate in the note and the AFR that applied, that it treats as a gift and as income. Whether the loan itself is respected as a genuine loan is a separate question (see the documentation section below). For a term loan, the gift tax figure is worked out differently from the yearly income figure: the tax code measures the gift up front, as the present value of the shortfall over the whole term. Whether any of it leads to tax depends on the loan size, the borrower's investment income and your other gifts that year, so it is worth having a CPA or tax attorney run your actual numbers before changing the note.
If you do amend or replace the note, our article on refinancing a family loan explains why a rate change should be a signed modification rather than an informal agreement, and why a modification can be measured against the AFR for the month it is signed. How to change your loan's terms shows how to update the rate in Family Loan Tracker without losing payment history.
The IRS's own explanation of below-market loans is in Publication 550, and the rule itself is 26 U.S.C. Section 7872.
This is general information, not tax or legal advice. How these rules apply to your loan depends on your facts, so check with a CPA, tax attorney or the attorney who drafted your note.
How to find the current AFR
The IRS updates the AFR table monthly. The most reliable source is IRS.gov/applicable-federal-rates, which lists all three tiers for the current and recent months. For a faster check, our free AFR calculator shows this month's rates and tells you which tier applies to your loan term. Our AFR table by month lists every month of 2026 with the revenue ruling it comes from.
When you use the rate, note which tier applies based on your loan's term. A 7-year loan uses the mid-term rate; a 15-year loan uses the long-term rate.
AFR and family loan documentation
Charging the AFR rate is not enough on its own. The IRS also looks for evidence that the transaction is a genuine loan — a written agreement, a repayment schedule, and actual repayments being made. A loan charged at the AFR rate but never repaid is more likely to be reclassified as a gift regardless of the rate.
When you set up a loan in Family Loan Tracker, you can enter any interest rate and the tool calculates exact payment schedules and interest totals, making it straightforward to confirm you're meeting the AFR minimum before committing. A complete payment history in the tracker also serves as documentation of actual repayments — an important part of demonstrating genuine loan intent.
For a deeper look at what the IRS considers a legitimate family loan — and how documentation affects that determination — see our complete family loan tax guide, which covers imputed interest and gift tax implications in more detail.
