Our CPA guru, Ian Schechter is back with another post from our CPA corner on the accounting and taxability of our Peer to Peer Lending investments. As usual, my comments will be in braces [like this]. Also, every tax situation is different so you should consult your own tax advisor and if you don't have one, then you should use Ian. Reach out to me and I'll get his contact info to you.
Remember, our income on our loan portfolios is in the form of Interest.
What Is Investment Interest?
“Investment Interest” is interest paid or accrued on indebtedness properly allocable to property held for investment. A simple example of this is interest or a dividend that is paid or received on a bank or portfolio account. [So you notice here that by paid or accrued means this could result in Income and Expenses and a positive or a negative number.]
Just as investment interest income is taxed by the government, related investment interest is deductible from your income, up to the point of net investment income. “Net investment income” is simply the excess of investment income over investment expenses.
[If the interest is earned by you in your personal name, then you might have to add it to your income on your 1040 as seen below here in lines 8a or 8b if its exempt from taxes or not]
Examples of deductible investment interest
The most common example of deductible investment interest is interest paid from a portfolio account. If, in your portfolio account, there is interest from any investment activity like borrowing on margin, it is considered investment interest expense. The exception to this is if you have tax-exempt income in your portfolio, you cannot deduct the related expense. The deductible investment interest is prorated between taxable and tax-exempt interest. [In our P2P lending accounts, the service fees are an expense.]
Another example of deductible investment interest is the interest on a seller-financed mortgage. If Person A (seller) sells a piece of property to Person B (buyer) and holds the note (mortgage) on the property, the interest portion of the note is investment interest income to the seller. In addition, if the seller has a mortgage on the house with a bank, then the interest paid by the seller is deductible investment interest expense. (The buyer’s interest paid is considered fully deductible Qualified Residence Interest, assuming it is their primary residence).
Where do I report my investment interest expense?
Investment interest expenses are reported on Form 4952 and flow through to Schedule A. [Below is something that looks familiar to all homeowners as it is the section of the Schedule A where we report our mortgage interest so we can itemize the deduction. Note line 14 is for Investment Interest Expense.]
What if my investment expense exceeds my investment income?
If your investment interest expense exceeds your investment interest income, the excess expense is carried forward indefinitely, and may be used in a subsequent year when investment income exceeds investment expenses.
Stu here and it's important to note that Interest Expense needs to be tracked as well as Interest Income and expenses can be carried over into additional years. There are different ways this can be accounted for and your tax rates on that interest will vary.