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Interest-Free Loans to a Church


Could a church borrow from church members at a 0% interest rate? Do “imputed interest” rules apply to such loans? Is there any limitation that a church member needs to be aware of before loaning funds to the church under these conditions?


To answer the first question, yes, a church could receive loans from church members with a 0% interest rate. This type of loan is usually classified as a below-market gift loan. In a sense, the church member who is lending the money is transferring an annual amount equal to the forgone interest to the church as a gift. The church, however, simultaneously transfers such interest back to the lender. This is the idea of imputed interest.

Were it not for limitations related to Schedule A itemized deductions, a donor would report equal amounts of the foregone interest as taxable interest income, but enjoy offsetting charitable contribution deduction.

However, an exception to this unfortunate consequence does exist. According to 2018 U.S. Master Tax Guide,“… in the case of gift loans between individuals (gift loans between individuals and charities are not discussed) where the total amount of outstanding [debt] does not exceed $100,000, the amount deemed transferred from the borrower (the church for purposes of our discussion) to the lender (a church member) at the end of the year will be imputed to the lender only to the extent of the borrower's annual net investment income (Code Sec. 7872(d))." 

For example, a donor lends $200,000 to his church when the applicable federal rate of interest (published monthly by the IRS) is 5 percent per year. The imputed interest, therefore, is $10,000. Without the exception described above, the donor must report $10,000 of interest income and then attempt to deduct a $10,000 charitable contribution. 

However, like most churches, the funds are not used to invest in financial instruments that produce investment income for the benefit of the church. Rather, the funds are used for facility or ministry purposes. It would not be uncommon for the church to have earned significantly less than $10,000 per year of investment income. In such cases, the above rule regarding imputed interest is irrelevant and requires no interest income--charitable contribution gymnastics. 

Presumably, the church as the borrower will have little net investment income since donors are unlikely to be motivated to grant interest-free loans to ministries that simply invest loans from members in stocks, bonds or other investment property.

Churches considering such alternatives for financing are well advised to consult with an attorney experienced in local state securities laws, since non-tax law issues may be more pertinent than tax considerations.

All that to say, if a church is considering accepting a interest-free loan from one of its members, we recommend keeping in mind Proverbs 22:7, "the borrower is servant to the lender." Under this type of arrangement the church is servant to the church member, who is expecting timely principal payments. Further, wise member lenders should expect two documents: a promissory note and a mortgage. These documents will limit the church's flexibility in pursuing additional debt and result in potential foreclosure actions should the church violate the promissory note.


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