Private lending agreement and tax implications

9 Replies

Hello team,

My partner and I are currently trying to purchase a value add 8 plex. Our banker will let us do 80/20. We are currently at 15%. I recently found a family member willing to loan us the other 5%. I was thinking of paying her simple interest of 8% yearly. She would be loaning us around 20k. She currently is on social security and takes 1300 per month from her retirement portfolio. My question is, how will this affect her taxes? I want to make sure this is a good deal for her. Thanks for any help or advice you can give. Let me know if more info is needed.

Ryan.

If you 1099 her the interest expense and she reports it on her 1040 then it's treated as ordinary income.

To clarify, if you 1099 her then she is obligated to report it on her 1040 since the act of doing so is to report it to the IRS who will then be looking to see it on her 1040. I am aware there are some circumstances whereby you are not obligated to 1099 someone, but I defer to your tax professional for counsel on that. 

@Ryan Proffit

You may or may not be required to provide her a 1099-INT.
Not everyone is required to do so.

Interest income is subject to federal and state income taxes.
If her only other income is social security, standard deduction may be enough to wipe out all her taxable income.

I know the person is a family member, but be wary on providing tax advice as you may not know everything about her taxes.

@Ryan Proffit Is she taking this out of a retirement account subject to penalties for early withdrawal? If so, the penalty is 10% plus any gains that are withdrawn are taxed at regular income rates. If it's a return of principal, there is nothing more than the 10% penalty.

Ryan I borrowed some cash from my mother in law at 2%. (I got a family discount on the rate). Initially it was used to buy a house my wife and I lived in, and we provided her a 1099 for the interest. I suggested I reimburse her for the tax she would have paid on the interest for the year, but she said she would have been taxed on it sitting in her account the same amount. 

In your case it seems to me that the $1600 income for the year would maybe be $200 in additional taxes? I don't know how the IRS does their voodoo with numbers, and every case is vastly different. Just my best guess for you and probably nowhere near accurate.