Lending money to a family member or close friend feels like an act of generosity. It can also become an act of profound financial self-harm if you don’t understand how HMRC treats the arrangement. The tax consequences of informal family loans catch people out every year — not because the rules are especially complex, but because most people never think to check them until a tax bill or a relationship breakdown forces the issue.
Whether you’re a parent helping with a house deposit, siblings splitting the cost of a buy-to-let, or a friend bridging someone’s cash-flow gap, the distinction between a loan and a gift determines everything. Get it wrong and you face unexpected Income Tax, Capital Gains Tax, or Inheritance Tax liabilities — sometimes all three.
The Lender’s Position: Income Tax on Interest
If you charge interest on a loan to family or friends, that interest is taxable income. It doesn’t matter that you’re not a bank. HMRC treats interest received as savings income, and you must declare it on your Self Assessment tax return. It’s taxed at your marginal rate: 20%, 40%, or 45% depending on your total income. You may benefit from the Personal Savings Allowance (£1,000 for basic-rate taxpayers, £500 for higher-rate), but beyond that threshold, every penny of interest is assessable.
The ghost income trap
Here’s where it gets uncomfortable. If your written agreement specifies an interest rate but you never actually collect the interest — perhaps out of kindness — HMRC can still argue the income was receivable and therefore taxable. The legal entitlement to receive interest is what matters, not whether you enforced it. If you genuinely want the loan to be interest-free, state that explicitly in writing. A vague or contradictory agreement is worse than no agreement at all.
Interest-Free Loans: Simpler, but Not Risk-Free
A genuinely interest-free loan between individuals generates no Income Tax liability for either party. The borrower doesn’t pay tax on the principal received (it’s not income), and the lender earns nothing to declare. So far, so straightforward.
The risk lies elsewhere. An interest-free loan is an immediately chargeable transfer for Inheritance Tax purposes if the lender dies before the loan is fully repaid. The outstanding balance forms part of the lender’s estate. More insidiously, if HMRC decides the “loan” was never really a loan — because there’s no written agreement, no repayment schedule, and no evidence of any repayments actually being made — they’ll reclassify it as a gift. That has serious IHT consequences, which we’ll address below.
Inheritance Tax: The Overlooked Time Bomb
This is the area most people miss entirely. Under current rules, gifts above the annual exemption (£3,000 per tax year, with the ability to carry forward one unused year) are potentially exempt transfers (PETs). They only escape IHT completely if the donor survives seven years. Die within that window and the gift is clawed back into your estate, potentially at 40%.
A genuine loan is not a gift — the debt remains an asset in your estate. But if you lend £100,000 interest-free and never chase repayment, HMRC may treat it as a gift made at the point you stopped expecting repayment. The seven-year clock doesn’t start when you handed over the money; it starts when the “loan” effectively became a gift, which is often impossible to pinpoint. This ambiguity is exactly the kind of mess that triggers costly disputes with HMRC.
Practical protection: maintain a written loan agreement, set a realistic repayment schedule, and ensure at least some repayments are actually made. Evidence of genuine loan behaviour is your best defence.
Capital Gains Tax: When You Lend Assets, Not Cash
Transferring cash carries no CGT liability. But if you transfer an asset — shares, a second property, cryptocurrency — to a family member or friend, HMRC treats that as a disposal at market value, regardless of what you actually received. You could face a significant CGT bill even though no money changed hands.
Between spouses and civil partners, transfers are at no gain/no loss — effectively CGT-free. But this relief does not extend to parents and children, siblings, unmarried partners, or friends. The 2024-25 CGT annual exempt amount is just £3,000, so even modest asset transfers can trigger a liability.
The Borrower’s Position: Can You Deduct the Interest?
If you borrow money from family for personal use — a car, a wedding, clearing credit card debt — any interest you pay is not tax-deductible. Full stop.
If the borrowed funds are used to generate taxable income, the picture changes. Interest on a loan used to purchase a buy-to-let property or invest in a business may be deductible, but only if you can demonstrate a clear link between the borrowing and the income-producing activity. For buy-to-let landlords, the old system of deducting mortgage interest against rental income has been replaced by a 20% tax credit — and this applies equally to interest paid on family loans used for property investment.
HMRC will scrutinise informal arrangements more aggressively than commercial ones. You need a formal written agreement specifying the loan amount, interest rate, and repayment terms. You need bank statements showing money flowing both ways. Without this documentation, a claimed deduction is an invitation for HMRC to open an enquiry.
Loans via Family Companies and Trusts
If the loan comes from a family company rather than an individual, the rules are materially different and considerably harsher. Under the ‘loans to participators’ rules in Section 455 of the Corporation Tax Act 2010, the company must pay a temporary tax charge of 33.75% on the outstanding loan balance if it isn’t repaid within nine months of the company’s year-end. The tax is eventually refunded when the loan is repaid, but it’s a substantial cash-flow hit.
If the loan is written off, the borrower is taxed as if they received a dividend. If the borrower is also a director or employee, HMRC may additionally treat the benefit of a below-market-rate loan as a benefit in kind, assessable through PAYE. The thresholds and exemptions here are narrow, and the penalties for getting it wrong are real. Take professional advice before lending through a company structure.
Stamp Duty Land Tax: A Trap for Co-Purchasers
If you’re lending money to help someone buy a property and you end up on the title as a co-owner — perhaps for security — beware the SDLT surcharge. If either co-buyer already owns residential property anywhere in the world, the 3% higher rate applies to the entire purchase price. This catches first-time buyers who innocently add a property-owning parent to the deed. The surcharge on a £300,000 purchase adds £9,000 to the tax bill. Structure the arrangement as a documented loan secured by a legal charge instead.
What You Should Actually Do
- Put it in writing. A formal loan agreement should specify the amount, interest rate (even if zero), repayment schedule, and what happens on default. Execute it as a deed — this gives a 12-year limitation period for enforcement rather than six years for a simple contract.
- Decide: loan or gift. If you never expect the money back, don’t pretend it’s a loan. Make a clean gift and start the seven-year IHT clock running honestly.
- Keep records. Bank transfers, repayment receipts, and correspondence. If HMRC queries the arrangement in five years, you need a paper trail that proves its commercial reality.
- Declare interest income. If you charge interest, report it. If you don’t want to charge interest, say so explicitly in the agreement.
- Take professional advice for anything involving property, companies, or trusts. The interaction of CGT, SDLT, IHT, and corporation tax creates traps that no single article can fully map.
Family lending can be a genuinely helpful financial tool — but only when both parties understand and respect the tax framework around it. The cost of a properly drafted agreement and a brief consultation with a tax adviser is trivial compared to the cost of an HMRC enquiry, an unexpected tax bill, or a broken relationship. Treat informal lending with the same seriousness you’d give a commercial transaction, because HMRC certainly will.
Disclaimer: The information provided in this article is for informational purposes only and should not be considered financial or legal advice. Property and lending laws in the United Kingdom vary and may change over time. We always recommend consulting with a qualified solicitor and mortgage broker before entering into a property purchase or financial arrangement with another party.
