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Tax, SDIRAs & Cost Segregation

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Denis Z.
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Private lending - investment vs business income

Denis Z.
Posted Jan 17 2024, 20:42

Hi everyone,

I am having a challenge understanding requirements for qualifying PL as a business income as opposite to investment income. I have W2 job and just starting in real estate. I have LLC registered for all of my activities that include (supposed to include) rental, fix&flip, etc. as well as private lending. On private lending side marked myself as PL, reviewed about 20-40 projects with lending requests this year, and got income from 4 notes. Not much income from other activities in 2023 (I just started). I have expenses related to REI business and ideally would like to see hem to be used against my PL income. All the posts I read on the BP forum suggests that my PL income can be qualified as business income, but in discussions with my CPA I am just stuck at "it is an investment income, you can't sue it to offset your REI business expenses". Any chance someone can help me to understand what do I miss?

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David M.
  • Morris County, NJ
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David M.
  • Morris County, NJ
Replied Jan 17 2024, 20:52

@Denis Z.

Yeah, i don't know what "they say," but my cpa says similar.  For me, its a 'passive business' income going on SchC.  So, its a different bucket than my long term rentals.  But, still a different from my active, SchC income activities.

Not sure what is your real estate income that you are specifically looking to offset.  Rentals will be in their own passive "bucket."  Flips will be active income (subject to self-employment tax).

Maybe for others they are actively, not the technical IRS term, doing private lending, i.e. MUCH more than 4 Notes.  That might make it an active business for them.

I certainly understand the point of view of your cpa.  Its still a passive activity for you.  So, that's why s/he is calling it an "investment actiivty" instead of a "business activity."  You can split hairs all you want whether its a "business," but what you are doing doesn't raise itself to being an active income source.  I think you need to pass the material participation tests (not the same as for long term rentals) and whatever else to be considered active income by the IRS.

Either way, I don't THINK there is another way to offset long term rental income as it is its own carve out by IRS code.

Hope that helps.  Happy to chat.  Good luck.

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Zachary Jensen
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#4 Tax, SDIRAs & Cost Segregation Contributor
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  • San Diego, CA
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Zachary Jensen
Tax & Financial Services
#4 Tax, SDIRAs & Cost Segregation Contributor
  • Accountant
  • San Diego, CA
Replied Jan 18 2024, 07:05
Quote from @Denis Z.:

Hi everyone,

I am having a challenge understanding requirements for qualifying PL as a business income as opposite to investment income. I have W2 job and just starting in real estate. I have LLC registered for all of my activities that include (supposed to include) rental, fix&flip, etc. as well as private lending. On private lending side marked myself as PL, reviewed about 20-40 projects with lending requests this year, and got income from 4 notes. Not much income from other activities in 2023 (I just started). I have expenses related to REI business and ideally would like to see hem to be used against my PL income. All the posts I read on the BP forum suggests that my PL income can be qualified as business income, but in discussions with my CPA I am just stuck at "it is an investment income, you can't sue it to offset your REI business expenses". Any chance someone can help me to understand what do I miss?

So private lending if done < 12 months is not investment income, its taxed as regular income. Interest, late fees, extension fees, underwriting fees, etc are all income. You can offset regular income with real estate losses if you are a real estate professional, which as you mentioned with your w2 is not possible. If your spouse was a RE pro, that would be a different case. You could also make your fix and flip projects into short term rentals and try to go for the "short term rental loophole". LLC is passthrough entity for tax purposes, unless you elect to be taxed as a C or S corp.

I don't know your specific situation, but I feel this accountant you are working with now may not be a real estate-focused CPA? There are solutions to explore here to offset this income it seems he is either not aware of or he doesn't think fit your situation. 

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