3 tips for making a personal loan

Lending even a small amount to a cash-strapped family member or friend can lead to big trouble if you’re not careful. To help avoid possible default, negative tax consequences and strained relationships:

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1. Put it in writing. Draft a simple contract that includes the names of the parties, the amount of the loan and repayment details — such as when term and balloon payments are due.

2. Charge interest. Interest formalizes the loan and prevents tax complications. If you’re making a term loan, charge interest equal to or greater than the current applicable federal rate (updated monthly at irs.gov) and report any interest you receive as income on your tax return. When making a demand loan (for which you can request repayment at any time), seek expert advice, because the tax treatment is trickier.

3. Lend only what you can afford to lose. Despite your borrower’s best intentions, there’s no guarantee he or she will pay you back — and in that event, it’s unlikely you’ll have the heart to take legal action. 

Other articles in the August 2013 Edition of Business Matters: