Private Lending and Tax Implications

3 Replies

I am interested in private lending my capital out to real estate investors, but I'm not sure if there is better more tax efficient way of lending that would reduce my tax burden. My capital is not located in IRA'S, 401K, or any other investment class. I would be wanting to invest 100% cash. Any advice?

*This is a preliminary question to gather more info prior to consulting a CPA.  

I'm really interesting in reading the responses to this question, too. One think I learned while doing some research in CA, is that since the recession and all of the foreclosures, a lot of rules really tightened up regarding lending and there are restrictions on how many loans you can hold, etc. I just bookmarked some sites with the regulations and don't know them all yet, but just a heads-up that you should find out the regulations, if you choose to do this.

@Brian Bonetta

1) It may be better to lend from a SDIRA or Solo401k. It doesn't seem like you have funds in either but something to consider for the future.

2) Is your lending at the level of a trade or business? If this is yes, you may be eligible to write off some items to come up to ordinary income. Some negatives come with this so best to talk to your accountant.

Agree with Basit. 

Tax planning is important if you plan to lend in any significant amount. Generally, the income is interest income taxed at ordinary income rates. So, without tax planning, your after-tax rate of return will get slashed and therefore, so will your ability to "compound" your interest income year over year.

To prepare for a talk with the CPA, the best thing you can do is to determine some lending goals  for yourself (i.e., approximately how much interest income you project each year for the next couple of years).   That will help your CPA help you determine a plan.

First choice (by far): talk to your CPA about creating and funding a self-directed IRA or 401K to make loans from those accounts.

Second choice: talk to your CPA about setting up a regular (i.e., not a retirement plan) entity from which to lend as an active trade of business (and whether to elect s-corp status).  This will probably hinge on how much interest income you expect to make each year over the next few years.  Whether or not you elect s-corp status, you will at least get to take some deductions if they are eligible (e.g., travel for continuing ed, business meals with borrowers, phone/internet expenses).  If you plan to have significant interest income, your CPA might recommend electing S-corp status to save on self-employment income.  Also, the income earned from an active trade or business will provide you "earned income" from which you can contribute to your retirement accounts to grow your "tax sheltered money pot".