Money between family members is always a little weird. You want to help your sister buy her first condo or maybe lend your son some cash for a business venture, but the IRS is basically standing in the corner with a clipboard. That’s where the applicable federal rate today comes into play. If you don't use it, a simple act of kindness can turn into a tax nightmare involving "deemed gifts" and unexpected interest income.
Most people think they can just do a 0% interest loan. You can't. Well, you can, but the IRS will treat it as if you should have charged interest based on the AFR, and then they'll tax you on that imaginary money. It’s annoying.
The rates change every single month. They are released by the Internal Revenue Service under Section 1274(d) of the Internal Revenue Code. For January 2026, we are seeing the ripple effects of the Federal Reserve’s long-term dance with inflation. It's not just one number. It’s actually a grid of numbers depending on how long the loan is going to last.
The AFR Breakdown You Actually Need
There are three main flavors of the applicable federal rate today.
First, you’ve got the Short-Term AFR. This is for loans of three years or less. It’s usually the lowest. Then there’s the Mid-Term AFR, which covers anything over three years but not more than nine. This is the "sweet spot" for most car loans or small business startups. Finally, the Long-Term AFR is for those big 15 or 30-year family mortgages.
Let’s look at the actual numbers for January 2026. For a mid-term loan with annual compounding, the rate is sitting at 3.98%. If you go short-term, it's 4.12%. Why is the short-term higher? That’s called an inverted yield curve, and it’s basically the bond market’s way of saying "things are a bit funky right now."
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It matters.
If you lend $100,000 to your daughter for a house today and you use the 3.84% long-term rate (compounded annually), you’re playing by the rules. If you charge 0%, the IRS assumes you’re giving her $3,840 a year in interest. If you’ve already used up your annual gift tax exclusion—which is $19,000 per person in 2026—you might have to dip into your lifetime estate tax exemption. Nobody wants to fill out Form 709 just because they were being nice.
Why Does the IRS Even Care?
Tax avoidance. That's the short answer. Back in the day, wealthy families would shift income to their kids in lower tax brackets by giving them massive interest-free loans. The kid would invest the money, pay taxes at a 10% or 12% rate, and the parents would keep their own income in the 37% bracket.
Congress got tired of it.
They created Section 7872. This section basically says that if you don't charge at least the applicable federal rate today, the transaction is a "below-market loan." Once you're in that territory, the IRS recharacterizes the whole thing. They pretend you received the interest and then gave it back to the borrower as a gift. It's a double whammy of paperwork and potential taxes.
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Real World: The Intra-Family Mortgage
Think about the housing market. Even in 2026, traditional mortgage rates are still hovering way above 6% for most people. If you have the liquidity, you can act as the bank.
By using the applicable federal rate today, you can offer your relative a rate that is significantly lower than what a bank would offer, while still staying legal. You’re happy because you’re earning more than you would in a basic savings account. They’re happy because they aren't paying 7% to a corporate lender.
- Step 1: Check the Rev. Rul. (Revenue Ruling) for the current month.
- Step 2: Draft a formal promissory note. Do not skip this. If it's not in writing, the IRS might call the whole loan a gift from day one.
- Step 3: Set a repayment schedule.
- Step 4: Actually collect the payments.
If you don't collect payments, the IRS might argue it wasn't a "bona fide" loan. If it wasn't a loan, then the whole $100,000 or $500,000 was a gift. That can trigger a huge tax bill if you’ve already used your lifetime limits.
The Section 7520 Rate: The AFR’s Sophisticated Cousin
While we are talking about the applicable federal rate today, we have to mention the 7520 rate. This is technically 120% of the mid-term AFR, rounded to the nearest two-tenths of a percent. For January 2026, the 7520 rate is 4.8%.
This is the number that matters for estate planning tools like GRATs (Grantor Retained Annuity Trusts) or charitable lead trusts. If you’re trying to move wealth out of your estate, you want a low 7520 rate. When the rate is low, the "hurdle" for these trusts is lower. If your investments grow at 8% but the IRS hurdle is only 4.8%, that 3.2% difference passes to your heirs totally tax-free.
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It’s a massive loophole that is perfectly legal, but it requires precise timing with the monthly rate changes.
What Most People Get Wrong
People often think the rate is fixed based on when they start thinking about the loan. Nope. It’s fixed when the loan is actually "inked." If you sign the paperwork on the 31st of the month, you use that month's rate. If you wait until the 1st, you use the new one.
Also, don't forget about compounding. The IRS publishes rates for annual, semiannual, quarterly, and monthly compounding. If your kid is paying you back every month, use the monthly rate. It’s usually slightly lower than the annual rate to account for the frequency of payments.
Honestly, the biggest mistake is just ignoring it for "small" loans. There is a "de minimis" exception for loans under $10,000, as long as the money isn't used to buy income-producing assets. But once you hit $10,001, the AFR rules apply. Don't risk a fight with the Treasury over a few percentage points.
Actionable Steps for Using the AFR
If you are planning to lend money or set up a trust this month, you need to be precise. The applicable federal rate today isn't just a suggestion; it's a safe harbor.
- Verify the current month's Revenue Ruling. For January 2026, that's Rev. Rul. 2026-01. Don't rely on old blog posts from three years ago.
- Match the term to the rate. If the loan is for 5 years, use the Mid-Term rate. Don't try to use the Short-Term rate just because it's lower; the IRS will catch that.
- Formalize the debt. Use a written promissory note that specifies the interest rate, the repayment schedule, and what happens if they default. You can find templates online, but having a CPA or lawyer look at it for twenty minutes is worth the peace of mind.
- Record the interest. As the lender, you must report the interest you receive as income on your 1040. The borrower might be able to deduct the interest if it's for a mortgage or a business expense, but that depends on their specific situation.
- Watch the calendar. If rates are trending down, wait until the first of the month to sign the papers. If they are trending up, sign them before the month ends to lock in the lower rate for the life of the loan.
Using these rates correctly is one of the easiest ways to keep the IRS out of your family's business while still helping the people you care about.