Investor / Lender · Seattle, WA · Member since 2014 · 1k+ posts · 730 votes
If I have personal loans from family and friends (to invest in real estate), can I deduct the interest I pay to them? I recently learned that there are some interest expenses that you can't deduct, and was wondering if this was one of them?
Investor and CPA · Arvada, CO · Member since 2015 · 2k+ posts · 3k+ votes
9y
@Account Closed
I see you are new to Bigger Pockets just this week, so I'll see if I can provide a little guidance for you.
Here at Bigger Pockets, you will see people talking about their investments and you will see people doing stuff you have never heard of or who do things a little differently than you do them.
The cool thing about Real Estate Investing is that there is no one right way. There is no cookie cutter approach. No "one size fits all". Real Estate Investing is as unique as each individual or group of individuals.
Coming across with your strong opinions that your opinion is the only right way is going to, quite frankly, irk quite a few people. Please note that the OP did not ask *how* to structure his agreement with friends and family - he simply asked if he could deduct the interest.
Folks gave him some additional pointers that he may not have considered regarding the topic, which is perfectly cordial and acceptable.
Your insistence that your opinion is the only right way for him to structure thing is not going to win you any friends here and, if you are looking to network, you will be unable to find folks to partner up with if you have such a narrow view of how real estate investing ought to be done.
Open your mind up a bit and allow for some other points of view and you'll do very well here.
What the OP is doing is perfectly fine and legitimate and, if that's the way he and his friends and family would like to structure things, then by all means it's not up to us to criticize that unless he asks "hey guys, what do you think of this structure?"
Note that what you are suggesting might carry the added burden of capital LOSSES for his friends and family, not just capital GAINS. A loan position is much safer and usually carries guaranteed income for the lender whereas the equity position you are insisting on shares quite a bit of risk that the OPs friends and family may not want.
CPA · New York, NY · Member since 2016 · 203 posts · 132 votes
9y
Nghi Le Are they picking up the interest income? If so (they should be), you can deduct the interest. You need to issue them a 1099 and communicate up front that this is required.
Hope this helps.
Accountant · Fort Lauderdale, FL · Member since 2013 · 1k+ posts · 753 votes
9y
They need to be including the interest income on their tax returns.
As for deductibility, under the interest tracing rules, if the debt can be traced to real estate investments, then you can deduct the interest on Schedule E (assuming you are a buy and hold investor purchasing in your name).
Professional · Beverly Hills, CA · Member since 2017 · 88 posts · 35 votes
9y
Why are you being mean to them? If they are giving you money to invest in Real Estate cut them in on the deal - give them capital gains as a reward not income taxed at marginal rates
This was helpful. Is there anything special I need to do in order to make it traceable and deductible? Family and friends want to keep things simple, so they don't want to deal with a deed of trust, liens, foreclosures, etc. Just a simple promissory note.
We may purchase the properties in an LLC, but that LLC will be in another state (as the properties are in another state). I thought about having them lend to the LLC, but am afraid they would need to file a tax return in that state, which really complicates things for them because in my state there is no state income tax. So I thought the personal loan would be a better route. What do you think about this?
@Account Closed
I'm not sure I agree with your blanket statement. We are putting in money and time into our investments. I expect the same from all equity partners. Our friends and family aren't necessarily putting in the bulk of the money either; $5k here, $10k there, etc. They came to us wanting a better place to park their money than the bank or traditional investments, and they wanted a no-hassle return on their money (and not have to deal with tenants and toilets).
Rental Property Investor · San Diego, CA · Member since 2013 · 3k+ posts · 4k+ votes
9y
Sure. Why not? I've borrowed from friends and Family. I pay them a mortgage same as I would a bank. I write off the interest same as I would a bank.
And obviously the amount that's interest income for them is taxable (not that this has anything to do with the fact that it's deductible for you).
Rental Property Investor · San Diego, CA · Member since 2013 · 3k+ posts · 4k+ votes
9y
Dee Jantsan Banks that lend to me don't get a "piece of the deal". Why would friends and family be different that loan you money?
If the property loses money and there are no profits to share, your lender still get paid their interest and principal. They are in it for their set fixed payments, not the chance of upside at the chance of downside
Professional · Beverly Hills, CA · Member since 2017 · 88 posts · 35 votes
9y
@Nghi Le Your attitude is selfish - you have given no thought to the tax consequences on the generous people who have given you money. You can set their reward at a maximum to suit your greediness - but there is no justification to seek to gain a tax benefit for yourself at their expense.
If you were to pay them 10% then after tax they would net around 7% - if you give them 5% they will end up with only 3.5% (marginally above the inflation rate)
CPA · New York, NY · Member since 2016 · 203 posts · 132 votes
9y
@Nghi Le Traceable just means that you can prove the funds from the loan went to the real estate investment that you are claiming the expense for. Don't take the personal loan, buy a car and then try to deduct interest expense on a rental property!
Investor / Lender · Seattle, WA · Member since 2014 · 1k+ posts · 730 votes
9y
@Account Closed mentioned). If we lost money in the investment, we still intend on paying our lenders their rate until we pay off the loan.
If they invested in other things, they have to pay tax on it as well. So how am I screwing them over by having them pay taxes on ours? It would still be a higher return than what they're getting, and we talk with them first about what return they will get before and after taxes and make sure they are comfortable with it.
Rental Property Investor · San Diego, CA · Member since 2013 · 3k+ posts · 4k+ votes
9y
Originally posted by @Account Closed:
@Nghi Le Your attitude is selfish - you have given no thought to the tax consequences on the generous people who have given you money. You can set their reward at a maximum to suit your greediness - but there is no justification to seek to gain a tax benefit for yourself at their expense.
If you were to pay them 10% then after tax they would net around 7% - if you give them 5% they will end up with only 3.5% (marginally above the inflation rate)
I totally disagree. He's giving them interest income. Their tax situation on that income shouldn't be a factor. People invest in CD's and other interest baring vehicles all the time for the purpose of getting interest (knowing it'll be taxed as income)
The people loaning him money likely have it in a bank making 1% (and being taxed on that meager 1% earnings). So if they loan it to him and he pays 6%, they're still 6x better off.
Professional · Beverly Hills, CA · Member since 2017 · 88 posts · 35 votes
9y
@Nghi Le You say they are Family and friends, who should be treated as such. They are not complete strangers! If they have the decency to give you money do the right thing by family - Don't behave like Shylock.
Their participation in profits can be limited to the equivalent you would pay as interest to an external lend - but by being paid as an equity profit then after 12 months it would be at gains tax rate of 15%. If their income is low at present they would appreciate paying little or no tax on what you give them.
In JVs a rule of thumb is MONEY gets half - so apportion the money return accordingly. The other 50% of profits they do not share unless they put in work and brain power.
Investor and CPA · Arvada, CO · Member since 2015 · 2k+ posts · 3k+ votes
9y
@Account Closed
I see you are new to Bigger Pockets just this week, so I'll see if I can provide a little guidance for you.
Here at Bigger Pockets, you will see people talking about their investments and you will see people doing stuff you have never heard of or who do things a little differently than you do them.
The cool thing about Real Estate Investing is that there is no one right way. There is no cookie cutter approach. No "one size fits all". Real Estate Investing is as unique as each individual or group of individuals.
Coming across with your strong opinions that your opinion is the only right way is going to, quite frankly, irk quite a few people. Please note that the OP did not ask *how* to structure his agreement with friends and family - he simply asked if he could deduct the interest.
Folks gave him some additional pointers that he may not have considered regarding the topic, which is perfectly cordial and acceptable.
Your insistence that your opinion is the only right way for him to structure thing is not going to win you any friends here and, if you are looking to network, you will be unable to find folks to partner up with if you have such a narrow view of how real estate investing ought to be done.
Open your mind up a bit and allow for some other points of view and you'll do very well here.
What the OP is doing is perfectly fine and legitimate and, if that's the way he and his friends and family would like to structure things, then by all means it's not up to us to criticize that unless he asks "hey guys, what do you think of this structure?"
Note that what you are suggesting might carry the added burden of capital LOSSES for his friends and family, not just capital GAINS. A loan position is much safer and usually carries guaranteed income for the lender whereas the equity position you are insisting on shares quite a bit of risk that the OPs friends and family may not want.
Investor and CPA · Arvada, CO · Member since 2015 · 2k+ posts · 3k+ votes
9y
@Nghi Le - with regard to your original question....
The answer, as with most tax questions is "it depends".
If you have a business entity that has borrowed this money, then I would suggest that you could indeed write off this interest within the business and issue a 1099 to your lenders.
If the loan is to you personally that you have then used to invest with, and you are personally responsible for paying the loans, then you could write the interest off on your schedule A under Miscellaneous Deductions (subject to a 2% floor) as Investment Interest. This works much the same way as a margin account and, because this is personal debt, you would not be required to issue a 1099. Note that this does not absolve them from having to declare the income. All income must be declared all the time. No Exceptions. If I loaned you $100 and asked you to pay me back next week and I charged you $1 in interest for that, then regardless of what you used that loan for, I should declare that $1 in interest on my tax return.
A taxpayer's need to declare income is not negated by the lack of a 1099.
If you took the money your friends and family as a personal loan, then contributed all of it to your business entity, you could then use the Interest Tracing rules to deduct all or part of the interest (depending on how much you used for investing in your entity).
Professional · Beverly Hills, CA · Member since 2017 · 88 posts · 35 votes
9y
@Linda Waygant Yes I only recently joined BP - but I am no stranger to the world of finance and real estate.
Sorry for being self opinionated - if I see people doing things I do not approve of I prefer to pipe up and tell it as it is. Somethings just do not occur to people who only look at their own pot.
Of course there are many ways to skin a cat and I am pretty sure the are differences of opinion = and that was all I was doing - giving an opinion. I do not see that is verboten.
If I have personal loans from family and friends (to invest in real estate), can I deduct the interest I pay to them? I recently learned that there are some interest expenses that you can't deduct, and was wondering if this was one of them?
Hey Nghi! Trying to get free tax advice? =P
You'll need to get 1098 INT so you can deduct the interest paid (on your schedule A - personal interest, Schedule E - if real estate interest, 1065 - interest paid in a partnership structure, 1120 - interest paid in a business corporate structure, or etc return) and then the lender will get a form 1099 INT for them (family/friends) but this will be taxable income to them at their applicable rate.
Im guessing, given your structure you may be filing it on your 1065 Partnership or 1120S (if you filed sub-chapter S election) so 1099 to lender, 1098 to yourself so you can track interest paid and whose received it.
Real Estate Agent · Jacksonville, FL · Member since 2015 · 1k+ posts · 1k+ votes
9y
I don't expect they are issuing you a statement, since they are friends and not a bank. If you are going to take the deduction, then they need to pay taxes not the interest. If they do not, you and/or both parties will get a nastygram from our Uncle Sam. This is an easy one for them to find, since there should be a direct match from you to the lender.
There is an option on most IRS forms to check that you did not receive a paper stamens and just include the lender info and the amounts paid. As long as it matches they don't care. They never actually see the statements only the info.
I don't expect they are issuing you a statement, since they are friends and not a bank. If you are going to take the deduction, then they need to pay taxes not the interest. If they do not, you and/or both parties will get a nastygram from our Uncle Sam. This is an easy one for them to find, since there should be a direct match from you to the lender.
There is an option on most IRS forms to check that you did not receive a paper stamens and just include the lender info and the amounts paid. As long as it matches they don't care. They never actually see the statements only the info.
Not true - just because they don't get a form doesn't mean they don't have to pay taxes on it...
Investor · Gaithersburg, MD · Member since 2013 · 659 posts · 441 votes
9y
Not really sure why Dee feels so strongly about this, but if that's his opinion, he has the right to give it. I don't necessarily agree with it in this case (I'll say why later), but if Dee was going to borrow money from family and friends and he wanted to cut them in on the deal (profits), I wouldn't disagree with that either. It's however you want to handle your deals. There isn't a wrong way to do things (unless you aren't being truthful somewhere).
Now, for the reason I disagree in this case. I am going to make an assumption. That assumption is that you were up front and honest with your family and friends on what they would be getting. If you were and they are happy with what they are getting and want to lend you the money, it's all good. So my assumption is that you told them what they'd get and how it would work, they are happy, and all is right in the world. With that being said, yes, you can write off that interest. As long as you are 100% using that money to fund real estate deals and it's not a situation where you've used any of that money for something personal (like buying a jet ski), then it's absolutely an expense that you should write off.
To touch on another point, you should issue them a 1099 for the interest you have paid them every year. It's not your responsibility whether or not they actually report it. You have no control over that. If you issue the 1099 and file it, and they don't report it, the IRS goes to them, not you. If it's someone that isn't used to doing those kinds of things on their taxes, when you send them their 1099, you can remind them they need to report the income on their taxes (since they are family and friends), but it's not required.
Investor · Philadelphia, PA · Member since 2010 · 739 posts · 372 votes
9y
@Account Closed is simply talking about the loan setup. What happens after the deal is sold is up to him (which would be a separate taxable event if he were to pay out his lenders on top of the interest).
Investor and CPA · Arvada, CO · Member since 2015 · 2k+ posts · 3k+ votes
9y
Originally posted by @Account Closed:
@Linda Waygant Yes I only recently joined BP - but I am no stranger to the world of finance and real estate.
Sorry for being self opinionated - if I see people doing things I do not approve of I prefer to pipe up and tell it as it is. Somethings just do not occur to people who only look at their own pot.
Of course there are many ways to skin a cat and I am pretty sure the are differences of opinion = and that was all I was doing - giving an opinion. I do not see that is verboten.
My point is that it is not your place (nor mine either) to approve or disapprove of anything. If you see something clearly illegal, you might have a duty to point that out, but otherwise I think you'll make more contacts and be more successful networking if you are aware of tone as you express your opinion.
Sure, in this post you state that differences are ok, but that's certainly not how you came across at first blush.
Professional · Beverly Hills, CA · Member since 2017 · 88 posts · 35 votes
9y
@Albert Bui I have a fair bit of understanding of tax rules - with 20 years experience as a Corporate Tax Lawyer and Financial Planner - which is why I suggested structuring the loans in such a way as to produce Capital Gains instead of Income for the lenders.
As you have no idea of how then you need to get educated. Yes ...
Rental Property Investor · Sioux Falls, SD · Member since 2015 · 9k+ posts · 18k+ votes
9y
@Nghi Le everyone is talking around the issue, but here is the bottom line.
They issued you a loan and they are required by federal law to claim that income and pay taxes. You are entitled to a tax deduction for interest paid if used for your business. The two are completely related, because for you to claim a deduction, they need to be claiming income and paying taxes.
You are not screwing anyone by claiming your rightful deduction. I hope nobody here is trying to imply just because they are family that they should not be required to pay federal taxes like the rest of us...