Imputed Interest & the AFR

Legal information, not legal advice — and not tax advice. Verify against the cited statute, regulation, and the live IRS revenue ruling before acting. The Applicable Federal Rate changes every month and the dollar thresholds adjust annually; a rate that is “safe” this month may not be next month. Last verified: 2026-06-08.

• What it is: When a contract for deed (a/k/a installment land contract, bond for deed, agreement for deed) charges no interest or a stated rate below the government’s minimum, federal tax law does not take the contract at its word. It recharacterizes part of what the parties call “principal” as interest — called imputed or unstated interest — computed by discounting the deferred payments back to present value at the Applicable Federal Rate (AFR), the minimum interest rate the IRS publishes monthly. The two operative Code sections are I.R.C. § 1274 (debt instruments given for property where there is inadequate stated interest) and I.R.C. § 483 (the residual unstated interest rule for transactions § 1274 does not reach). Both discount at the AFR “determined under section 1274(d).” 26 U.S.C. §§ 1274(b)–(d), 483(b)–(c).

• Why it matters for contract-for-deed: A seller-financed CFD is the textbook case these sections were written for — a debt instrument given in consideration for the sale of property with payments stretching past six months (§ 1274(c)(1)). Operators are tempted to set a low or zero interest rate to make the “interest” number small (it is ordinary income, taxed worse than the capital-gain “principal” that rides the installment method under irc-453-installment-sale). That does not work. If the stated rate is below the AFR, §§ 1274/483 reimpute interest anyway: the seller reports the same ordinary-interest income it tried to hide, the buyer’s basis and the seller’s amount realized are reduced to the imputed principal, and the parties have gained nothing while inviting an IRS adjustment. Setting the rate at or above the term-matched AFR is the single cleanest way to keep a CFD’s tax characterization intact. It also interacts with the state usury ceiling at the other end of the rate band — the AFR is a federal floor for tax purposes, the state cap a ceiling for enforceability (usury-and-interest-caps) — so the compliant rate lives in the corridor between them.

• How the AFR works (the mechanic): The Treasury publishes three AFRs every month by revenue ruling, keyed to the term of the debt instrument (§ 1274(d)(1)): the federal short-term rate for a term not over 3 years, the mid-term rate for a term over 3 but not over 9 years, and the long-term rate for a term over 9 years. “During each calendar month, the Secretary shall determine the Federal short-term rate, mid-term rate, and long-term rate which shall apply during the following calendar month.” § 1274(d)(1)(B). A CFD typically amortizes over 10–30 years, so the long-term AFR is usually the governing rate, but a short balloon can fall in the mid- or short-term bucket — match the bucket to your amortization term, not the calendar. The AFR is the minimum: a rate at or above the applicable AFR (compounded at least annually) gives the contract “adequate stated interest,” so the stated principal stands and nothing is reimputed. § 1274(c)(2), (b)(3) (adequate stated interest exists “if the stated principal amount … is less than or equal to the imputed principal amount”).

• The lowest-of-three-months lock-in: For a sale under a binding written contract, the operator is not stuck with the AFR in the closing month. Under § 1274(d)(2) the applicable AFR is “the lowest of the applicable Federal rates in effect for any month in the 3-calendar-month period ending with the 1st calendar month in which there is a binding written contract” — and Treas. Reg. § 1.1274-4(a)(2) lets the parties take the lower of that figure or the equivalent three-month window ending when the sale actually occurs. Practically: lock a binding contract, then you may use the lowest AFR of that month and the two preceding months for the life of the note. In a rising-rate environment this can shave the safe minimum; in a falling-rate environment it rarely matters.

• The § 1274A 9% safe-harbor cap: For a “qualified debt instrument” — defined by a stated principal amount at or below an inflation-adjusted ceiling (statutory base $2,800,000, § 1274A(b); the live figure is higher and must be confirmed each year) — the discount rate “used for purposes of sections 483 and 1274 shall not exceed 9 percent, compounded semiannually.” § 1274A(a); Treas. Reg. § 1.1274-4(a)(2)(ii) (“Under section 1274A(a), the test rate for a qualified debt instrument is no greater than 9 percent, compounded semiannually”). So the test rate a CFD seller must meet is the lower of the term-matched AFR or 9%. With current AFRs far below 9% (see the live figures below), the 9% cap is dormant — but it is the reason IRS Pub. 537 phrases the test-rate ceiling as “9%, compounded semiannually” for seller financing of the qualifying amount or less.

• The § 483(e) family-land 6% cap: On a sale of land between family members (spouse, siblings, ancestors, lineal descendants — § 267(c)(4)), the discount rate for unstated interest “shall not exceed 6 percent, compounded semiannually,” but only up to $500,000 of sales price between those two individuals in a calendar year (excess is tested at the normal AFR), and not if any party is a nonresident alien. § 483(e). A parent selling the back forty to a child on a CFD may therefore use a 6% test rate even if the long-term AFR is higher — a meaningful break for intra-family terms-sales up to the cap.

• No-interest CFDs and the § 7872 boundary: A zero-interest “owner will finance, no interest” CFD does not escape imputation — § 1274 (or § 483) supplies the interest the contract omits. It is not governed by the below-market-loan rules of § 7872: that section “shall not apply to any loan to which section 483 … or 1274 applies.” § 7872(f)(8). Because a CFD is a debt instrument given for property, §§ 1274/483 control and § 7872 is displaced — a clean rule that keeps gift-loan mechanics out of an ordinary seller-carry sale (though a true gift element in an intra-family bargain sale can still raise separate gift-tax questions outside this page).

• The carve-outs where the AFR floor does not bite: § 1274 does not apply to several CFD-relevant sales — most importantly total payments of $250,000orless\ast \ast (\S 1274(c)(3)(C)),a\ast \ast saleoftheselle{r}^{\prime }sprincipalresidence\ast \ast (\S 1274(c)(3)(B)),anda\ast \ast farmsalebyanindividual/estatefor$1,000,000 or less (§ 1274(c)(3)(A)). But the floor is not gone in those cases: § 483 picks up most of them (its own floor is sales over $3,000), so a small CFD still imputes interest under § 483 at the same AFR even though § 1274’s OID machinery is switched off. The carve-outs change which section applies and the accounting mechanics, not the basic “use the AFR” duty.

• Operator takeaway: State the CFD interest rate at or above the AFR for your amortization term, compounded at least annually, and you are done with imputation. Determine the term bucket (short ≤3 yrs / mid >3–9 / long >9), pull the current month’s AFR from the live IRS revenue ruling (or the lowest of the three-month window if you have a binding contract), and set your stated rate ≥ that figure (or ≥ 6% on a §483(e) family-land sale up to $500k; never more than the §1274A 9% test-rate cap is required). Then sanity-check the ceiling: confirm the rate sits under the state usury cap (or within a recognized exemption / DIDMCA preemption — usury-and-interest-caps). A rate in the safe corridor — at or above the AFR, below the usury line — keeps the deal both tax-clean and enforceable.

▸ For Sellers / Operators — Compliance-critical, in order. (1) The AFR is a hard floor, not a suggestion. A below-AFR or zero-interest CFD does not convert ordinary interest income into capital gain; §§ 1274/483 reimpute the interest, cut the buyer’s basis to the imputed principal, and hand the IRS a clean adjustment. (2) Pick the right term bucket. Most CFDs amortize >9 years → the long-term AFR governs; a balloon at ≤3 or ≤9 years uses the short- or mid-term rate. (3) Use the lowest-of-three-months lock (§ 1274(d)(2)) once you have a binding written contract — the lowest AFR of the closing month and the two prior months. (4) Know the special caps: the test rate never has to exceed 9% (§ 1274A, for a “qualified debt instrument” under the inflation-adjusted ceiling), and an intra-family land sale uses a **6% cap up to $500,000/yr\ast \ast (\S 483(e)).(5)\ast \ast TheAFRisthefloor;thestateusuryceilingisthecap\ast \ast —setthestatedrateinthecorridorbetweenthem([[usury-and-interest-caps]]),andonafirst-lienresidentialCFDrememberDIDMCAmaypreemptthestatecapentirely.(6)\ast \ast Smalldealsarenotexempt:\ast \ast \S 1274^{\prime }s$250k / principal-residence / $1M-farmcarve-outsjustshuntthedealinto\ast \ast \S 483\ast \ast ,whichimputesatthesameAFRonanysaleover$3,000.

▸ For Buyers — Imputed interest changes your numbers too. When the seller states no or below-AFR interest, the IRS treats part of each “principal” payment as interest you paid (potentially deductible as home-mortgage interest if it qualifies) and correspondingly reduces your cost basis in the property to the imputed principal — which raises your taxable gain when you later sell. Ask for the stated rate to be set at the AFR up front so the contract’s principal and your basis line up with reality.

Jurisdiction map

Imputed interest and the AFR are federal rules — they apply identically in all 56 jurisdictions and override any contrary state characterization for federal income-tax purposes. There is therefore no state-by-state split on the AFR itself. The “split” that matters operationally is the interaction with each state’s usury ceiling, which sets the upper bound of the same rate the AFR sets a lower bound on: the compliant CFD rate must sit at or above the AFR and at or below the state cap (or within a recognized usury exemption / DIDMCA preemption). The table maps that corridor for the representative states whose usury position is sourced on usury-and-interest-caps; the federal floor row binds everywhere.

Position	Jurisdiction(s)	Controlling authority (primary source)
Federal floor — applies to ALL 56 jurisdictions — a below-AFR or zero-interest CFD has interest reimputed; discount the deferred payments to present value at the term-matched AFR (short ≤3 yrs / mid >3–9 / long >9), compounded ≥ annually; “adequate stated interest” if stated principal ≤ imputed principal	all	26 U.S.C. § 1274(b)–(d); 26 U.S.C. § 483(b)–(c); AFRs published monthly (current: Rev. Rul. 2026-11, June 2026)
9% test-rate cap (federal) — for a “qualified debt instrument” (stated principal ≤ inflation-adjusted ceiling, base $2.8M) the discount/test rate need not exceed 9% compounded semiannually	all	26 U.S.C. § 1274A(a)–(b); Treas. Reg. § 1.1274-4(a)(2)(ii)
6% family-land cap (federal) — sale of land between § 267(c)(4) family members uses a discount rate ≤ 6% compounded semiannually, up to $500,000 sales price/year between those individuals; no nonresident-alien party	all	26 U.S.C. § 483(e)
Floor meets a modest 10% legal-rate ceiling + draconian penalties — AFR sets the minimum; the Texas legal rate is 10% (higher ceiling under ch. 303), and overshooting risks treble-interest / principal-forfeiture penalties, so the corridor is real	texas	Floor: §§ 1274/483 · Ceiling: Tex. Fin. Code § 302.001, chs. 303/305 (via usury-and-interest-caps)
Floor meets a hard civil-16% / criminal-25% residential ceiling — no high-dollar escape for a 1–2-family residence; the AFR floor and the NY cap define a narrow band	new-york	Floor: §§ 1274/483 · Ceiling: N.Y. GOL § 5-501; Penal Law § 190.40 (via usury-and-interest-caps)
Floor meets an 18% civil / 25% criminal ceiling — the corridor is wide; AFR floor rarely conflicts with the FL cap	florida	Floor: §§ 1274/483 · Ceiling: Fla. Stat. § 687.03, § 687.071 (via usury-and-interest-caps)
Floor meets a cap that expressly governs the “land installment contract” — Ohio brings CFD interest inside its ceiling statute, so both the federal floor and a codified state ceiling bind the same rate	ohio	Floor: §§ 1274/483 · Ceiling: Ohio Rev. Code § 1343.01(A)–(B) (via usury-and-interest-caps)
Floor meets an exemption-rich cap — CA’s bare 7%/10% constitutional cap is widely escaped (broker-arranged real-property loans; time-price doctrine), so the AFR floor is usually the only binding number on a bona fide carryback	california	Floor: §§ 1274/483 · Ceiling/exemption: Cal. Const. art. XV § 1 (via usury-and-interest-caps)
First-lien residential CFD — state ceiling may be preempted, leaving only the federal floor — where DIDMCA preempts the state usury cap, the AFR floor is effectively the only rate constraint (still subject to UDAP/unconscionability)	all (non-opt-out)	Floor: §§ 1274/483 · Preemption: 12 U.S.C. § 1735f-7a (via usury-and-interest-caps)

How the rules fit together

• The corridor, concretely. The AFR is the minimum rate that avoids imputation; the state usury cap is the maximum rate that keeps the contract enforceable. For June 2026, the long-term AFR is 4.87% (annual) / 4.81% (semiannual) — so a 30-year CFD in, say, texas (10% legal rate) has an easy corridor of roughly 4.87%–10%. In new-york (civil cap 16% for a residence, but the AFR floor still 4.87%) the corridor is wider on top but the criminal-25% line is the hard stop. Where DIDMCA preempts the state cap on a first-lien residential deal (usury-and-interest-caps), the AFR floor is essentially the only rate rule left.

• § 1274 vs. § 483 — which section runs the floor. Both discount at the same AFR (§ 483 borrows “the applicable Federal rate determined under section 1274(d)”). The practical difference is the accounting: § 1274 generates original issue discount (OID) that the seller accrues into income over the term on a constant- yield basis, while § 483 imputes interest more simply on a payment-by-payment basis. § 1274 governs the typical CFD; § 483 catches the carve-outs § 1274 excludes (principal-residence sale; ≤ $250,000totalpayments;\le$1,000,000 farm sale by an individual). Either way the minimum rate is the AFR.

• The two statutory rate caps are buyer-favorable, not seller-traps. § 1274A’s 9% ceiling and § 483(e)‘s 6% family-land ceiling cap the rate the IRS may impute against the parties — they protect a low-rate deal from being tested at an artificially high discount rate, not the other way around. They never require a rate above the AFR; they only cap how high imputation can reach.

• State law cannot lower the federal floor. A state usury cap or a state recharacterization of a CFD as a “credit sale” (the time-price doctrine, usury-and-interest-caps) governs enforceability under state law and has no effect on the federal imputed-interest computation. Even a bona fide time-price credit sale that a state treats as carrying no interest will have interest imputed federally under §§ 1274/483 if the stated rate is below the AFR. The two regimes answer different questions and both must be satisfied.

Worked example (June 2026 AFRs, illustrative)

Seller sells a house on a 20-year CFD for $200,000,nomoneydown,andwantstostate\ast \ast 0governs.June2026long-termAFR=\ast \ast 4.872026-11).Becausethestated0statedinterest,sounder\S 1274(b)the\ast \ast imputedprincipalamount\ast \ast isthepresentvalueofall240paymentsdiscountedat4.81$200,000. The difference is imputed interest the seller must report as ordinary income over the term as OID, and the buyer’s basis is the lower imputed principal, not $200,000.Hadthesellersimply\ast \ast stated4.87thereis"adequatestatedinterest,"the$200,000 stated principal stands, and nothing is reimputed. (This example is illustrative arithmetic on retrieved rates, not a computation of any specific deal — confirm the live AFR and run the actual present value before relying on it.)

Primary sources (retrieved 2026-06-08)

• 26 U.S.C. § 1274 — issue price = stated principal where there is adequate stated interest, else the imputed principal amount (b) = sum of present values of all payments discounted at the AFR compounded semiannually; (c)(1) scope (debt given for property, payment due > 6 months after sale); (c)(3) exceptions (farm ≤ $1M(A);principalresidence(B);totalpayments\le$250,000 (C); § 483(e) related-party land (F)); (d)(1) AFR by term (short ≤3 / mid >3–9 / long >9), Secretary determines monthly; (d)(2) lowest-of-3-months for a binding contract. https://www.law.cornell.edu/uscode/text/26/1274
• 26 U.S.C. § 483 — (a) portion of total unstated interest treated as interest; (b) total unstated interest = excess of payments over their present value at the § 1274(d) AFR; (c) applies to payments due > 6 months after sale where some payment is due > 1 year out and there is unstated interest; (e) 6% cap on land sales between § 267(c)(4) family members up to $500,000/yr, no nonresident-alien party. https://www.law.cornell.edu/uscode/text/26/483
• 26 U.S.C. § 1274A — (a) discount/test rate for §§ 483 and 1274 “shall not exceed 9 percent, compounded semiannually” for a qualified debt instrument; (b) “qualified debt instrument” = stated principal ≤ **$2,800,000\ast \ast (base,beforeinflationadjustment);(c)cash-methodelection(\le$2,000,000 base); (d)(2) inflation adjustment under § 1(f)(3), rounded to nearest $100. https://www.law.cornell.edu/uscode/text/26/1274A
• 26 U.S.C. § 7872(f)(8) — below-market-loan rules “shall not apply to any loan to which section 483, 643(i), or 1274 applies” (a seller-financed property sale is governed by §§ 483/1274, not § 7872). https://www.law.cornell.edu/uscode/text/26/7872
• Treas. Reg. § 1.1274-4 — AFR for a debt instrument is based on its term (short/mid/long); the 3-month rule (lower of the lowest AFR in the 3-month period ending with the binding-contract month, or the period ending when the sale occurs); “Under section 1274A(a), the test rate for a qualified debt instrument is no greater than 9 percent, compounded semiannually” (this 9% test-rate phrasing is at § 1.1274-4(a)(2)(ii); the 3-month rule is at § 1.1274-4(a)(1)(ii)). https://www.law.cornell.edu/cfr/text/26/1.1274-4
• Treas. Reg. § 1.483-1 — unstated interest is treated as interest, excluded from the seller’s amount realized and the buyer’s basis; “adequate stated interest” where the stated rate is at least the test rate (determined under § 1.483-3) and interest is paid/compounded at least annually. https://www.law.cornell.edu/cfr/text/26/1.483-1
• Rev. Rul. 2026-11 (June 2026 AFRs) — Table 1 Applicable Federal Rates for June 2026: Short-term 3.85% annual / 3.81% semiannual; Mid-term 4.13% annual / 4.09% semiannual; Long-term 4.87% annual / 4.81% semiannual. AFRs are published monthly under § 1274(d). https://www.irs.gov/pub/irs-drop/rr-26-11.pdf · index: https://www.irs.gov/applicable-federal-rates
• IRS Publication 537 (rev. 2025), Installment Sales — operationalizes §§ 1274/483 (unstated interest / OID) and the test-rate ceilings for seller financing; see irc-453-installment-sale for the installment-method overlay. https://www.irs.gov/publications/p537

Meta

• last_verified: 2026-06-08
• confidence: 0.9
• gap_score: 1
• needs_verification:
  • Current-year inflation-adjusted § 1274A dollar ceilings — the base figures ($2,800,000qualified-debt-instrumentlimit;$2,000,000 cash-method limit) are the statutory text retrieved this run, but both adjust annually under § 1274A(d)(2)/§ 1(f)(3). IRS Pub. 537 (2025) stated the inflation-adjusted seller-financing test-rate ceiling as $7,296,700; the live 2026 figure was not retrieved verbatim this run. Confirm the current-year amount before relying on the 9% cap’s reach.
  • Treas. Reg. § 1.483-3 (test-rate definition) and § 1.1274-2/§ 1.1272-1 (OID accrual mechanics) — referenced but not retrieved verbatim this run; the constant-yield OID accrual schedule and the exact “test rate = lower of AFR or 9%” reg phrasing should be confirmed against the CFR before computing a specific deal.
  • Whether a CFD with contingent or variable payments (e.g., a participating or shared-appreciation CFD) is tested under § 1274 or the contingent-payment rules of § 1.1275-4 — not analyzed this run; flag for a future concepts/contingent-payment-cfd.md.
  • § 1274(c)(3)(A) farm-sale and (B) principal-residence carve-out interplay with § 483 — confirmed that § 1274 excludes these and § 483 generally picks them up (floor: sales > $3,000),butthepreciseboundary(e.g.,aprincipal-residenceCFDthatalsoexceeds$250k) was not traced through both sections’ regs this run.
• open_questions:
  • Does a wrap/junior-lien CFD (wrap-around-mortgage) change the imputed- interest computation? (It should not — §§ 1274/483 test the buyer’s debt instrument regardless of the seller’s underlying loan — but confirm the present-value base is the wrap balance, not net equity.)
  • When DIDMCA preempts the state usury ceiling on a first-lien residential CFD (usury-and-interest-caps), is the AFR the only remaining rate constraint, or do CFPB ability-to-repay / UDAP doctrines impose an effective ceiling (dodd-frank-seller-financing)? Normalize with the usury page.
  • For an intra-family § 483(e) sale that also implicates gift tax (bargain sale below FMV), how do the 6% income-tax cap and the gift-tax valuation interact? Outside this page’s scope; flag for a future gift-tax note.
• cross_links: irc-453-installment-sale · usury-and-interest-caps · dodd-frank-seller-financing · safe-act-mlo · installment-land-contract · wrap-around-mortgage · texas · new-york · florida · ohio · california
• changelog:
  • 2026-06-08 — Page created. Explained imputed/unstated interest and the AFR as applied to a low/no-stated-interest CFD: the § 1274 (inadequate stated interest / OID) and § 483 (unstated interest) recharacterization mechanic; the three term-keyed AFRs (§ 1274(d)(1)) and the lowest-of-three-months binding-contract lock (§ 1274(d)(2)); the § 1274A 9% test-rate cap and the § 483(e) 6% family-land cap (up to $500k);the\S 7872(f)(8)exclusionofbelow-market-loanrules;andthe\S 1274(c)(3)carve-outs(principalresidence,\le$250k, ≤ $1M farm) that shunt a deal into § 483. Built the federal-floor / state-usury-ceiling “corridor” table linking texas, new-york, florida, ohio, california via usury-and-interest-caps. All primary text retrieved this run: 26 U.S.C. §§ 1274, 483, 1274A, 7872; Treas. Reg. §§ 1.1274-4, 1.483-1; Rev. Rul. 2026-11 (June 2026 AFRs: ST 3.85% / MT 4.13% / LT 4.87% annual). Flagged the live § 1274A inflation-adjusted ceiling, § 1.483-3 test-rate reg, the OID accrual mechanics, and contingent-payment treatment under needs_verification.

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Disclaimer. This page is legal information, not legal advice — and not tax advice — and may be out of date. The Applicable Federal Rate changes every month, and the dollar thresholds and the § 1274A inflation-adjusted ceiling change annually; the Internal Revenue Code is amended and IRS revenue rulings and Publication 537 are revised continually. Confirm the current U.S.C. text, the live monthly AFR revenue ruling, and the applicable Treasury Regulations, and consult a qualified tax professional before setting an interest rate or relying on any item here for a specific contract for deed.