Each month, the IRS publishes the applicable federal rates (AFR) and related tables on the IRS website.
There are three types of AFR which are:
- Short Term AFR. Used for instruments with a term of three years or less.
- Mid Term AFR. Used for instruments with a term of at least three years but less than nine years.
- Long-Term AFR. Used for instruments with a term of greater than nine years.
Taxpayers use the AFR interest rates for various purposes, including:
- Calculating imputed interest
- Calculating the original issued discount (OID) on note obligations
- Present value of annuities
- Present value of a remainder or reversionary interest
The IRS website posts the following resources for taxpayers:
- Applicable Federal Rates (AFR) for each month
- Current Year Section 7520 Interest Rates
- Actuarial Tables for Annuities, Life Estates, Remainders & Reversionary Interests
- Historical Section 7520 Rates
Example AFR Use and Calculation
Adam wants to borrow $100,000 from his brother for a down payment on a house. Adam’s brother, John, agrees to loan Adam the money. They agree to a 5 year term with interest compounding annually. In order to avoid the transaction being classified as a gift, the loan should use an interest rate that is at least the federal AFR given the term of the loan and the compounding period.
John loans the funds to Adam in June 2024 when the applicable mid-term AFR is 4.66% for annual compounding. John and Adam agree to use the 4.66% interest rate on their promissory note.