Forgiving part of a family loan before December 31

Mark lent his daughter Priya $60,000 in January 2024 under a signed promissory note: 5% interest, 120 monthly payments of $636. She has not missed a payment. It is now autumn 2026, Priya has a second child on the way, and Mark wants to cancel part of what she owes before the year ends. He needs to know how much he can forgive, what he has to file, and what happens to the note afterwards.

Forgiving a debt is a gift. In Rev. Rul. 81-264 the IRS says that when there was no prearranged plan to forgive, the lender makes a gift at the time of the forgiveness. The gift tax rules therefore apply on the date you pick, to the amount you pick.

Forgive principal, not unpaid interest

Principal and interest are treated differently. Forgiven principal is a gift. Forgiven interest can also be income to the lender. A guide from the law firm Wiggin and Dana states that a lender who forgives interest on a note must still recognize the forgone interest as income. An estate planning article in the NAEPC Journal explains why: forgiven interest may be treated like the forgone interest on a below-market loan. That produces an imputed gift to the borrower and imputed interest income to the lender. The same article says a lender may be able to avoid recognizing accrued interest when the forgiveness also covers principal "in substantial part". That is a judgment call for an accountant, not a safe harbor.

The simple fix is timing. Date the forgiveness on a payment due date, after that payment has posted. Accrued interest is then zero and every forgiven dollar is principal.

If forgiven interest is treated as forgone interest, the below-market loan rules in section 7872 of the Internal Revenue Code come into play. Two thresholds matter for loans between individuals:

• $10,000. Section 7872 does not apply to a gift loan on any day the total outstanding loans between the two people are $10,000 or less. The exception does not cover loans used to buy or carry income-producing assets.
• $100,000. For gift loans directly between individuals, the interest treated as income to the lender is capped at the borrower's net investment income. The cap applies only while the total loans stay at or below $100,000.

The family loan interest rate guide covers both in more detail.

Keep each lender's forgiveness within $19,000 for 2026

The annual gift tax exclusion for 2026 is $19,000 per recipient, the same as for 2025. The limit covers everything the lender gives that person during the calendar year, not just the forgiveness. If Mark already gave Priya $1,000 for her birthday, he has $18,000 of room left. Unused room does not carry forward. It resets on January 1.

You can forgive more than the exclusion. The lender files Form 709, and the excess reduces the lifetime estate and gift tax exemption. That exemption is $15 million per individual for 2026, up from $13.99 million for 2025. Gift tax is owed only once the exemption is used up. For most families, going over $19,000 means a return to file, not a tax bill.

Split the gift with your spouse to reach $38,000, and file Form 709

A married couple can elect to treat a gift of one spouse's property as made half by each. That raises the amount that stays within the exclusion to $38,000 per recipient for 2026. The election has conditions:

1. Both spouses must file Form 709. The IRS allows the split only if both file a return consenting to it, even when no tax is due.
2. The consent applies to every gift either spouse made to third parties during the year, not just the forgiveness.
3. Neither spouse can be a nonresident who is not a US citizen at the time of the gift.
4. Under the current form, the donor spouse attaches the other spouse's written consent, and the instructions say to send both returns in the same envelope.

Form 709 for gifts made in 2026 is due April 15, 2027. If April 15 falls on a weekend or legal holiday, the deadline moves to the next business day.

A worked example on Priya's note

Priya's December 1, 2026 payment is her 35th. After it posts, she owes $45,473 and has paid $7,747 in interest. If nothing changes, she will pay another $8,621 in interest over the remaining 85 payments. The original 10-year schedule carried $16,367 of interest in total.

Option 1: Mark forgives $19,000 alone. He has made no other gifts to Priya this year, so he files nothing. Her balance drops to $26,473.

Option 2: Mark and his wife Ana split the gift and forgive $38,000. Each spouse's half is $19,000, so no exemption is used and no tax is due, but both file Form 709 by April 15, 2027. Her balance drops to $7,473, which is also below the $10,000 threshold in section 7872.

In both cases the forgiveness is dated December 1, after the payment, so no interest is forgiven.

Decide whether the payment drops or the term shortens

A smaller balance can be repaid in two ways, and the letter should say which.

• Re-amortize over the remaining 85 months. After a $19,000 forgiveness the payment falls to $370 and the remaining interest is $5,019. After $38,000 it falls to $105 and the remaining interest is $1,417.
• Keep the $636 payment and finish early. After $19,000 the loan is paid off in 46 more payments, the last one $495, with $2,660 of interest. After $38,000 it takes 13 payments, the last one $41, with $205 of interest.

The shorter term saves Priya more interest. The lower payment leaves her more cash each month. You can check other amounts with the loan calculator, and the amortization schedule guide shows how each row is built.

Record the forgiveness on the ledger as its own entry, not as a payment, so the history keeps money received separate from money forgiven. On NoteHouse that entry sits on the ledger both of you see, and on the Standard plan the signed letter can be uploaded to the loan.

Put the forgiveness in a signed letter dated before December 31

The gift happens when the debt is forgiven, so the letter must be signed and delivered in 2026 to count against the 2026 exclusion. It should state:

1. The names of the lender and borrower, and the date and original principal of the note.
2. The amount of principal forgiven and the effective date.
3. That all interest has been paid through that date, or the exact amount of interest forgiven.
4. The new principal balance.
5. The new payment and maturity date, or that the payment stays the same.
6. That every other term of the note remains in force.

The lender signs. If you are splitting the gift, both spouses sign. Have the borrower countersign to acknowledge the new balance. Keep the letter with the original promissory note. An electronic signature works if the signing record is kept; see electronic signatures on promissory notes. If you forgive the whole balance, say so in the letter and mark the original note cancelled.

Avoid a pattern that makes the loan a gift from day one

In Rev. Rul. 77-299, a grandparent transferred land to grandchildren in exchange for notes payable in yearly amounts equal to the annual exclusion, which was then $3,000. A letter told the grandchildren the notes would be forgiven as they came due, and they were. The IRS ruled the notes were not real consideration and the whole transfer was a gift when it was made. An NAEPC Journal article notes that some courts have rejected this approach. Even so, a forgiven note can still lead to past-due gift tax with interest and penalties.

Courts weigh factors from a case known as Miller to separate loans from gifts: a note or other evidence of the debt, interest charged, security, a fixed maturity date, demands for repayment, actual repayment, and whether the borrower could repay. To keep the loan a loan:

• Charge at least the applicable federal rate when the note is signed. For October 2026, Rev. Rul. 2026-19 sets the annual rates at 4.25% short-term, 4.61% mid-term and 5.22% long-term. The IRS publishes each month's rates around the 20th of the month before.
• Collect the scheduled payments and record each one. If a payment is missed, follow the steps in when a borrower pays late.
• Put nothing in writing, at signing or later, that promises future forgiveness.
• Keep forgiveness in the lender's absolute discretion. Wiggin and Dana also advise that the note stay reachable by the lender's creditors and enforceable by the lender's estate.
• Do not forgive the same amount every year in place of payments. A forgiveness that matches the exclusion each December while no payments arrive looks like the plan in Rev. Rul. 77-299.

If you rewrite the note with new terms rather than just reducing the balance, ask your accountant whether the new note must meet the AFR for the month it is signed.

For a 2026 forgiveness, pick the December payment date and wait for the payment to post. Sign the letter that day. If you and your spouse are splitting the gift, put April 15, 2027 in the calendar.