Using HELOC for a hard money loan - tax implications?

Question

Let's say someone takes money out of a HELOC at 8% and lends it out as a hard money loan at 12%. After the loan is paid off, a 1099 is sent to the hard money borrower and the IRS showing the interest received. How can this be addressed at tax time so that only the actual income is taxed (12%-8%), not the whole 12%?

Nicholas Aiola · Answer

@Rumen Mladenov If the HML is in the business of lending, income will be taxed as ordinary income subject to SE tax and the HELOC interest paid would be deductible as a business expense.

If not, the income to the HML will be interest income (portfolio income) and the HELOC interest paid would be reported on Schedule A as investment interest. In this scenario, if the HML does not itemize, there will be no benefit received from the HELOC interest paid and the HML will be taxed on the full amount of interest income received.

Nicholas Aiola · Answer

@Anup Shah If you're in the business of lending, you would report income and expenses on Schedule C.

Anna N. · Answer

@Michael Plaks

Thank you Michael!  That's a great analogy and makes sense of the situation :)

Nicholas Aiola · Answer

@Rumen Mladenov If the HML is in the business of lending, income will be taxed as ordinary income subject to SE tax and the HELOC interest paid would be deductible as a business expense.

If not, the income to the HML will be interest income (portfolio income) and the HELOC interest paid would be reported on Schedule A as investment interest. In this scenario, if the HML does not itemize, there will be no benefit received from the HELOC interest paid and the HML will be taxed on the full amount of interest income received.

Kory Reynolds · Answer

To me... (It sounds like) this is something you are doing on a regular basis for the pursuit of profit, you are actively engaged with other investors to loan to, while it isn't a full time business, you are in the business of loaning money. If you did this as a one off, maybe we would call it regular interest income. Continuous? Likely we'll go with business income (subject to Self Employment tax) take as many deductions as we are entitled to (including the HELOC interest). We'll also (likely) get to benefit from the up to 20% qualified business income deduction.

Basit Siddiqi · Answer

@Rumen MladenovYour income is 12% - The question is if the 8% can be claimed as a deduction and if so where.Are you in the business of lending? Then the interest income is business income and the expense is a business deduction.If you are not deemed in the business of lending, the interest expense would be an itemized deduction. If you don't itemize, you may be paying taxes on the full 12%.

Anna N. · Answer

Hi all, I am also just catching up on this thread.  I spoke with a local accountant and was informed that HML is not considered "business of lending" as a sole proprietor.  And that individuals can't be comparable to the banks.  I also actively lend (HML) on about a dozen properties and hoping for some additional insight as to what determines "business of lending" on this scale.  Has anyone filed taxes as a sole proprietor based on HML activities?

Michael Plaks · Answer

You were MIS-informed. Or maybe you misunderstood what that accountant said.

You certainly can be in the business of lending as a private lender, and it has nothing to do with being a sole proprietor. It depends on the volume of your lending, the effort you put into it, the way you go about it, etc.

A lemonade stand is not a business, but a smoothie shop is. They do almost the same thing. The key is that one is a casual low-key low-volume temporary project, while the other is a "real" operation. Same with lending.

Anup Shah · Answer

Hi Folks, I am just catching up on this thread as I am in similar boat and lend regularly as HML. @Kory Reynolds, @Nicholas Aiola and @Basit Siddiqi have answered in detail so thanks to them.

My question is - If I am using online tax tool to file my return how do I show this as business expense and income if I don't have Schedule K1?

Rumen Mladenov · Answer

Thanks Kory. I did qualify for the QBI deduction on the rental income last year, will keep in mind for next year to check about the lending portion as well. Appreciate your input!

Using HELOC for a hard money loan - tax implications?

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