Taxes on Private/Hard money loans?

Question

Does anyone have professional guidance regarding how taxes work regarding private lenders or hard money lenders?  I was on both sides of this question last year and have not yet filed my taxes.

Two scenarios to consider:

1.  I borrowed $100,000 @ 8% for 12 months, ending April 2017.  I've paid this in full when I sold the property.  Is the full $108,000 a deductible expense on the Flip?  Is there any required documents I'll need to provide my accountant?

2. I loaned $40,000 to another investor at 20% interest.  I was in 2nd position and they were desperate...  I received full payment in September 2017.  Do I have to claim the $8,000?  If so, how do I report it?  Ordinary income? Capital Gains?  What documents will I need to provide, if any, to my accountant?

Thanks in advance!

Ronny

Jon Holdman · Answer

1. Only the interest is deductible, not the principal payment.

2. The interest you received is interest and you would report that as ordinary income.  Same as any other interest, typically documented with a 1099-INT.

Michael Jackson · Answer

Thanks for the passive aggressive and condescending reply internet troll @Eamonn McElroy.   I was differentiating between (1065) Line 1 Ordinary Business Income and Line 5 Interest Income, but you knew that, because you worked at one of the 10 largest accounting firms in ALL of Memphis.  I worked at one of the 4 largest in the WORLD.  Does that mean that I should stalk the internet looking for people to tear down too?

Funny that my first post on Bigger Pockets, an attempt to help someone in need, became the target of an internet troll with nothing better to do.  It's tax season big guy, go crank some 1040's.

Michael Plaks · Answer

@Eamonn McElroy and @Michael Jackson

There is no need for Nancy v. Donald on BiggerPockets, we're not politicians here.

I happened to be of the opinion that interest earned by professional private lenders or hard money lenders is ordinary income for their lending businesses (as in "in the business of lending money"), as distinct from portfolio income on passive investments and casual loans.

Eamonn - please correct me if I'm wrong and explain how would you classify the income and expenses of a HM lender, let's say operating as a partnership.

Basit Siddiqi · Answer

@Ronny Crawford1.  I borrowed $100,000 @ 8% for 12 months, ending April 2017.  I've paid this in full when I sold the property.  Is the full $108,000 a deductible expense on the Flip?  Is there any required documents I'll need to provide my accountant?The $8,000 is an interest expense deduction and will be used to lower the gain on your flip.

2. I loaned $40,000 to another investor at 20% interest.  I was in 2nd position and they were desperate...  I received full payment in September 2017.  Do I have to claim the $8,000?  If so, how do I report it?  Ordinary income? Capital Gains?  What documents will I need to provide, if any, to my accountant?You should report this interest income on your tax return. Please note that if this was a mortgage and the property was in another state than the one you live in - the interest income may be considered sourced to another state.If you continue to issue notes - you may be considered in the business of loaning money and the income characterization would change from portfolio interest income to ordinary income.

Eamonn McElroy · Answer

@Michael Plaks

Interest is ordinary income.  Ordinary income merely means the income is subject to ordinary graduated tax rates (hence, rental real estate income is also ordinary income).  Generally, interest income is also appropriately classified as portfolio income (ordinary income and portfolio income are not mutually exclusive) unless the lender is in the trade or business of lending money, at which point the income may be appropriately treated as trade or business income subject to SE taxes.

"explain how would you classify the income and expenses of a HM lender"

See the last sentence above.

"let's say operating as a partnership"

Same.  Except if the partner is limited or the functional equivalent of an LP, the SE tax component may be avoided.

Michael Plaks · Answer

@Ronny Crawford

Not sure why you're asking us and not your own CPA. Especially what documents he will need. Probably should have him explain various concepts that you seem to be confused about.

1. Profit on the flip has nothing to do with borrowing and repaying loans. Interest and fees are an additional deduction, but that's it. Everything else is calculated as if the whole deal was done in cash.

2. There is no capital gains when we talk about flips. It's business income, subject to ordinary tax rates PLUS self-employment tax.

3. You absolutely claim $8,000 as income. How you report it? At least two different ways: either as interest or as business income. Each has its pros and cons, that's why it's a question for your CPA. Not a capital gain.

Ann A. · Answer

Hi @Ronny Crawford and @John Wang - did you figure it out? I am trying to find answer to similar questions. Feel free to DM me.

Steven Hamilton II · Answer

That entirely depends upon if the lending activity even rises to the level of a trade/business:

Scallen v Commissioner 2002 and Cooper v Commissioner TC Memo 2015-191

• the total number of loans made;
• the time period over which the loans were made;
• the adequacy and nature of the taxpayer’s records;
• whether the loan activities were kept separate and apart from the taxpayer’s other activities;
• whether the taxpayer sought out the lending business;
• the amount of time and effort expended in the lending activity; and
• the relationship between the taxpayer and his debtors.

Kathie Riedel · Answer

I am in a similar situation. In general since I have no expenses except minor stuff I just report the interest income and pay tax. However, I did have a foreclosure and there were expenses on that. My CPA deducted those costs from the interest income. I had no separate entity.

Am sure more qualified people can add to this.

John Wang · Answer

Can anyone help me? I have a question. I am not a loan originator, I am an investor. Since 2017, I have been doing private lending through private/hard money loan originator. I receive 1099 interest income from loan servicing company, now I have about 20+ active loans with various brokers, other loans have been paid off.  Can this interest be considered “lending business” to report as “business income” i? If I can report lending income as business income, do I need to have any entity? Right now I do not have an entity? Can I just have a sole proprietorship, LLC, S Corp or do I have to have C Corp? What entity is the best in terms of tax saving? If I cannot treat interest income as business income, what entity or not having an entity do you recommend from tax saving perspective? Thank you.

Taxes on Private/Hard money loans?

Most Popular Reply