Tax implications for a private lender

[Eric Lunsford]

I apologize if this has been answered before. I did a brief search and didn't find anything that answered my question. 

I'm wondering how private lenders get taxed on their earned interest as they loan money to RE investors. My strategy for REI has been to build a portfolio directly purchasing and leasing real estate but at some point start to transition my funds into private lending others' opportunities and getting away from being the actual owner and manager of properties.

I know there are a lot of tax benefits and write offs associated with owning real estate that would be lost as a private lender, but can anyone tell me what to expect? If I lend money as a first lien holder and get interest payments only (no profit on the back end, etc.)? I also know this is dependent to the states as well, but generally speaking I'm curious on a federal level. 

Thanks in advance. 

[Rick Pozos]

When you lend money, you get interest. That interest is income. You will get a 1099int from the borrower, or maybe you will not, but it is still just interest income.

Don't worry about depreciation or other profit that you COULD HAVE gotten by doing something else, because you are not doing that, you are lending money. Everything has its benefits. Some better than others, but be happy with what you are doing.

I have lent money, done flips, wraps, rentals. They each have their own "thing". Don't worry about the thing that goes with the other types of deals. Do what is good for you.

Lending money is the easiest, low hassle, low worry way to make money. You lend someone money for 1 year, 5 years, 25 years and the money shows up in your account every month. Not exciting, not glamorous, but for the most part steady. You make lower returns like a CD or a Treasury Note. Lower risk, lower reward.

Flipping by yourself or with a partner is more risk, more potential reward(also more potential LOSS). Dealing with sellers, negotiating, getting to closing. Dealing with contractors and them showing up late or not at all. Selling the property working with realtors. LOTS of hassle. Could be more money.

For me, some of my money goes to rehabs, some goes to notes. I like a little variety. A solid base of steady income with a low return and exciting, headache filled days with sellers, contractors and buyers to make a little extra cash.

[Kyle J.]

@Eric Lunsford  Generally the interest income from private lending is taxed at the ordinary income tax rate, just like earned income from a job or interest on a bank savings account is taxed.

[Basit Siddiqi]

@Eric Lunsford

It really depends on if you are in the business of lending.

If you are not considered in the business of lending - the income is considered interest income and taxed at your marginal tax rate for both federal and state. You are not entitled to business deductions. You may potentially be entitled to some itemized deductions.

If you are considered in the business of lending - the income is considered business income and also taxed at your marginal tax rates for both federal and state. There may be potential self-employment taxes. You may be entitled to taking deductions used to generate your income.

[Jonathan Wong]

This is very helpful. 

[Pierre E.]

I had same question so this helps. Basically if possible, the best place to do private money lending from is a self directed IRA or self directed 401k it seems.

[Timur Abdullin]

How did you resolve your question, OP? It is now 1 year later.

[Timur Abdullin]

Originally posted by @Basit Siddiqi:

@Eric Lunsford

It really depends on if you are in the business of lending.

If you are not considered in the business of lending - the income is considered interest income and taxed at your marginal tax rate for both federal and state. You are not entitled to business deductions. You may potentially be entitled to some itemized deductions.

If you are considered in the business of lending - the income is considered business income and also taxed at your marginal tax rates for both federal and state. There may be potential self-employment taxes. You may be entitled to taking deductions used to generate your income.

Hello Basit.

Which state do you practice your CPA in? 

I want to lend cash from my pocket to a syndicated flipper in PA state as a private money lender. This will be my 1st deal of this kind.

Looking for the most efficient means to doing this. Looking for avoid taxes as much as possible.

Shall I lend as an individual? Shall I open a company and do it through said company? Please let me know if you are able to consult me on this topic.

My main source of income is a W-2. I am a civil engineer.

Thank you.

[Jay Hinrichs]

Originally posted by @Timur Abdullin:

Originally posted by @Basit Siddiqi:

@Eric Lunsford

It really depends on if you are in the business of lending.

If you are not considered in the business of lending - the income is considered interest income and taxed at your marginal tax rate for both federal and state. You are not entitled to business deductions. You may potentially be entitled to some itemized deductions.

If you are considered in the business of lending - the income is considered business income and also taxed at your marginal tax rates for both federal and state. There may be potential self-employment taxes. You may be entitled to taking deductions used to generate your income.

Hello Basit.

Which state do you practice your CPA in? 

I want to lend cash from my pocket to a syndicated flipper in PA state as a private money lender. This will be my 1st deal of this kind.

Looking for the most efficient means to doing this. Looking for avoid taxes as much as possible.

Shall I lend as an individual? Shall I open a company and do it through said company? Please let me know if you are able to consult me on this topic.

My main source of income is a W-2. I am a civil engineer.

Thank you.

its just interest income..  no real way around it unless your in the business and you can offset some of your interest income with business deductions but you still have to spend the money to deduct it.. although driving to your loans may allow some car write off perhaps.

but really your going to make money and pay tax's its better to concentrate on the collateral and a safe investment so you actually have some income to worry about.. 

[Basit Siddiqi]

Originally posted by @Timur Abdullin:

Originally posted by @Basit Siddiqi:

It really depends on if you are in the business of lending.

If you are not considered in the business of lending - the income is considered interest income and taxed at your marginal tax rate for both federal and state. You are not entitled to business deductions. You may potentially be entitled to some itemized deductions.

If you are considered in the business of lending - the income is considered business income and also taxed at your marginal tax rates for both federal and state. There may be potential self-employment taxes. You may be entitled to taking deductions used to generate your income.

Hello Basit.

Which state do you practice your CPA in? 

I want to lend cash from my pocket to a syndicated flipper in PA state as a private money lender. This will be my 1st deal of this kind.

Looking for the most efficient means to doing this. Looking for avoid taxes as much as possible.

Shall I lend as an individual? Shall I open a company and do it through said company? Please let me know if you are able to consult me on this topic.

My main source of income is a W-2. I am a civil engineer.

Thank you.

 I sent you a message

[Timur Abdullin]

Originally posted by @Jay Hinrichs:

Originally posted by @Timur Abdullin:

Originally posted by @Basit Siddiqi:

@Eric Lunsford

It really depends on if you are in the business of lending.

If you are not considered in the business of lending - the income is considered interest income and taxed at your marginal tax rate for both federal and state. You are not entitled to business deductions. You may potentially be entitled to some itemized deductions.

If you are considered in the business of lending - the income is considered business income and also taxed at your marginal tax rates for both federal and state. There may be potential self-employment taxes. You may be entitled to taking deductions used to generate your income.

Hello Basit.

Which state do you practice your CPA in? 

I want to lend cash from my pocket to a syndicated flipper in PA state as a private money lender. This will be my 1st deal of this kind.

Looking for the most efficient means to doing this. Looking for avoid taxes as much as possible.

Shall I lend as an individual? Shall I open a company and do it through said company? Please let me know if you are able to consult me on this topic.

My main source of income is a W-2. I am a civil engineer.

Thank you.

its just interest income..  no real way around it unless your in the business and you can offset some of your interest income with business deductions but you still have to spend the money to deduct it.. although driving to your loans may allow some car write off perhaps.

but really your going to make money and pay tax's its better to concentrate on the collateral and a safe investment so you actually have some income to worry about.. 

Thank you, Jay.

In my limited understanding of interest taxing, there are states which do not tax such income. They do not tax dividends, for example. But this is strictly from the state side. Federal taxation still applies everywhere: IRS.

Would it make sense to open up some legal business entity in one of those states?

Which entity most efficiently represents AND protects a money lender?

Also, how does interest taxation work if you live in state X but lend to a syndicating flipper in state Y? Do the 3 parties tax you at once: X, Y, and IRS?

Getting into very deep waters here. ;) 

[Jay Hinrichs]

Originally posted by @Timur Abdullin:

Originally posted by @Jay Hinrichs:

Originally posted by @Timur Abdullin:

Originally posted by @Basit Siddiqi:

@Eric Lunsford

It really depends on if you are in the business of lending.

If you are not considered in the business of lending - the income is considered interest income and taxed at your marginal tax rate for both federal and state. You are not entitled to business deductions. You may potentially be entitled to some itemized deductions.

If you are considered in the business of lending - the income is considered business income and also taxed at your marginal tax rates for both federal and state. There may be potential self-employment taxes. You may be entitled to taking deductions used to generate your income.

Hello Basit.

Which state do you practice your CPA in? 

I want to lend cash from my pocket to a syndicated flipper in PA state as a private money lender. This will be my 1st deal of this kind.

Looking for the most efficient means to doing this. Looking for avoid taxes as much as possible.

Shall I lend as an individual? Shall I open a company and do it through said company? Please let me know if you are able to consult me on this topic.

My main source of income is a W-2. I am a civil engineer.

Thank you.

its just interest income..  no real way around it unless your in the business and you can offset some of your interest income with business deductions but you still have to spend the money to deduct it.. although driving to your loans may allow some car write off perhaps.

but really your going to make money and pay tax's its better to concentrate on the collateral and a safe investment so you actually have some income to worry about.. 

Thank you, Jay.

In my limited understanding of interest taxing, there are states which do not tax such income. They do not tax dividends, for example. But this is strictly from the state side. Federal taxation still applies everywhere: IRS.

Would it make sense to open up some legal business entity in one of those states?

Which entity most efficiently represents AND protects a money lender?

Also, how does interest taxation work if you live in state X but lend to a syndicating flipper in state Y? Do the 3 parties tax you at once: X, Y, and IRS?

Getting into very deep waters here. ;) 

there are accountants answering you so I will leave the expert advice to them.. from what I know of HML of which I have been doing it for 40 years now.. you pay tax in the state you live.. If there is no income tax in the state you live in then I think its only federal.

some states may capture out of state lenders operating in their state and want income tax at the state level.

[Timur Abdullin]

Originally posted by @Jay Hinrichs:

Originally posted by @Timur Abdullin:

Originally posted by @Jay Hinrichs:

Originally posted by @Timur Abdullin:

Originally posted by @Basit Siddiqi:

@Eric Lunsford

It really depends on if you are in the business of lending.

If you are not considered in the business of lending - the income is considered interest income and taxed at your marginal tax rate for both federal and state. You are not entitled to business deductions. You may potentially be entitled to some itemized deductions.

If you are considered in the business of lending - the income is considered business income and also taxed at your marginal tax rates for both federal and state. There may be potential self-employment taxes. You may be entitled to taking deductions used to generate your income.

Hello Basit.

Which state do you practice your CPA in? 

I want to lend cash from my pocket to a syndicated flipper in PA state as a private money lender. This will be my 1st deal of this kind.

Looking for the most efficient means to doing this. Looking for avoid taxes as much as possible.

Shall I lend as an individual? Shall I open a company and do it through said company? Please let me know if you are able to consult me on this topic.

My main source of income is a W-2. I am a civil engineer.

Thank you.

its just interest income..  no real way around it unless your in the business and you can offset some of your interest income with business deductions but you still have to spend the money to deduct it.. although driving to your loans may allow some car write off perhaps.

but really your going to make money and pay tax's its better to concentrate on the collateral and a safe investment so you actually have some income to worry about.. 

Thank you, Jay.

In my limited understanding of interest taxing, there are states which do not tax such income. They do not tax dividends, for example. But this is strictly from the state side. Federal taxation still applies everywhere: IRS.

Would it make sense to open up some legal business entity in one of those states?

Which entity most efficiently represents AND protects a money lender?

Also, how does interest taxation work if you live in state X but lend to a syndicating flipper in state Y? Do the 3 parties tax you at once: X, Y, and IRS?

Getting into very deep waters here. ;) 

there are accountants answering you so I will leave the expert advice to them.. from what I know of HML of which I have been doing it for 40 years now.. you pay tax in the state you live.. If there is no income tax in the state you live in then I think its only federal.

some states may capture out of state lenders operating in their state and want income tax at the state level.

Thank you, Jay.

[David Roe]

As a buyer and you use a hard money loan to purchase and rehab a home the lender should issue a 1098 just as any other mortgage lender holding claim to the title correct?  Isn't it the Lean holder's responsibility issue 1098s on time?

[Eric DeStefano]

Quote from @Basit Siddiqi:

Originally posted by @Timur Abdullin:

Originally posted by @Basit Siddiqi:

It really depends on if you are in the business of lending.

If you are not considered in the business of lending - the income is considered interest income and taxed at your marginal tax rate for both federal and state. You are not entitled to business deductions. You may potentially be entitled to some itemized deductions.

If you are considered in the business of lending - the income is considered business income and also taxed at your marginal tax rates for both federal and state. There may be potential self-employment taxes. You may be entitled to taking deductions used to generate your income.

Hello Basit.

Which state do you practice your CPA in? 

I want to lend cash from my pocket to a syndicated flipper in PA state as a private money lender. This will be my 1st deal of this kind.

Looking for the most efficient means to doing this. Looking for avoid taxes as much as possible.

Shall I lend as an individual? Shall I open a company and do it through said company? Please let me know if you are able to consult me on this topic.

My main source of income is a W-2. I am a civil engineer.

Thank you.

 I sent you a message

 Basit - I have the same question as Timur. I have already lent money on 1 flip. Currently doing a second. Will probably continue to do more, as the returns have been good and steady.  

Thanks,

Eric

[Chris Seveney]

@Eric Lunsford

As mentioned it’s taxed at ordinary income - but there are debt funds that do private lending that can provide investors a 1099-DIV vs 1099-INT which is a considerable savings net taxes - it’s about 2pt delta - meaning 10% from debt fund is better than 12% taxed as interest (and a lot less work)

[Prem Jain]

Quote from @Eric DeStefano:

Quote from @Basit Siddiqi:

Originally posted by @Timur Abdullin:

Originally posted by @Basit Siddiqi:

It really depends on if you are in the business of lending.

If you are not considered in the business of lending - the income is considered interest income and taxed at your marginal tax rate for both federal and state. You are not entitled to business deductions. You may potentially be entitled to some itemized deductions.

If you are considered in the business of lending - the income is considered business income and also taxed at your marginal tax rates for both federal and state. There may be potential self-employment taxes. You may be entitled to taking deductions used to generate your income.

Hello Basit.

Which state do you practice your CPA in? 

I want to lend cash from my pocket to a syndicated flipper in PA state as a private money lender. This will be my 1st deal of this kind.

Looking for the most efficient means to doing this. Looking for avoid taxes as much as possible.

Shall I lend as an individual? Shall I open a company and do it through said company? Please let me know if you are able to consult me on this topic.

My main source of income is a W-2. I am a civil engineer.

Thank you.

 I sent you a message

 Basit - I have the same question as Timur. I have already lent money on 1 flip. Currently doing a second. Will probably continue to do more, as the returns have been good and steady.  

Thanks,

Eric

 How did you account for the interest income for tax purpose  for the money lent ? Did you generate 1098 or you asked the borrower to generate 1099 to you ?

[Chris Seveney]

@Prem Jain

Lender always generates the forms not the borrower

[Prem Jain]

Yes, I am a prospective lender looking for details on how to generate a 1098