Tax question personal loan

Non-investing personal finance issues including insurance, credit, real estate, taxes, employment and legal issues such as trusts and wills.
Post Reply
Topic Author
ge1
Posts: 816
Joined: Sat Apr 28, 2012 8:15 pm

Tax question personal loan

Post by ge1 »

I made several loans to a colleague for real estate related investments. He didn't actually pay me the interest, but when we rolled one loan into another, we increased the principal by the earned interest income. I assume I still have to declare the interest income as taxable income in 2015?
Tanelorn
Posts: 2366
Joined: Thu May 01, 2014 9:35 pm

Re: Tax question personal loan

Post by Tanelorn »

My understanding is that if you're a cash basis taxpayer, as individuals are by defualt, personal loan interest is taxable when paid, not when accrued. Your colleague still might not pay you on the accrued interest rolled into the new loan, after all.

If any tax experts come along, I would be curious to know whether the borrower can repay his principle before his interest in this case, loan documents or creditor permitting, and to pay the interest "last" from a taxable timing perspective.

https://www.irs.gov/publications/p17/ch ... 1000171541
http://finance.zacks.com/interest-promi ... -6584.html
Longdog
Posts: 2173
Joined: Sun Feb 09, 2014 5:56 pm
Location: Philadelphia

Re: Tax question personal loan

Post by Longdog »

Tanelorn wrote:My understanding is that if you're a cash basis taxpayer, as individuals are by defualt, personal loan interest is taxable when paid, not when accrued. Your colleague still might not pay you on the accrued interest rolled into the new loan, after all.

If any tax experts come along, I would be curious to know whether the borrower can repay his principle before his interest in this case, loan documents or creditor permitting, and to pay the interest "last" from a taxable timing perspective.

https://www.irs.gov/publications/p17/ch ... 1000171541
http://finance.zacks.com/interest-promi ... -6584.html
At the time of the new loan, it seems to me like the borrower effectively paid the interest (and principal) on the old loan, and then took out a new loan for the combined total. That's how bond refinancings work, so I'd expect this to be equivalent.
Steve
triskelion
Posts: 35
Joined: Sat Sep 20, 2014 8:18 am

Re: Tax question personal loan

Post by triskelion »

Unless you put out additional capital, the increase in capital would be interest paid. Make sure the rate charged is at least the IRS minimum to avoid imputed interest.

https://www.irs.gov/pub/irs-drop/rr-16-04.pdf
Topic Author
ge1
Posts: 816
Joined: Sat Apr 28, 2012 8:15 pm

Re: Tax question personal loan

Post by ge1 »

Thanks all for the feedback. Yes the rate is above the minimum IRS rates. Makes sense to me that the amount of interest earned rolled into the new loan would have to be declared as interest income.

Related to this a slightly different question: Can anybody think of a tax efficient way of making these loans? It's basically equivalent to holding a high yield bond fund in a taxable account, which isn't very tax efficient.
Tanelorn
Posts: 2366
Joined: Thu May 01, 2014 9:35 pm

Re: Tax question personal loan

Post by Tanelorn »

triskelion wrote:Unless you put out additional capital, the increase in capital would be interest paid. Make sure the rate charged is at least the IRS minimum to avoid imputed interest.

https://www.irs.gov/pub/irs-drop/rr-16-04.pdf
I don't see what in your link what addresses this point, aside from just giving the AFRs. Hopefully OP is charging considerably more than those!

You don't have constructive receipt of the interest unless you can actually get it, which is why it seems to me that a refinancing like this is more akin to accrued interest rather than a payment and reinvestment. If the lender really did pay him the money, he cashed the check into his bank, and then he re-loaned, I agree the interest would be paid and taxable as of that time. But if the borrower said, "well, I can't / don't want to pay now, but let's give you this bigger loan and I'll pay that off later, maybe", it's hard to argue you ever got paid (and might still never get paid). Certainly the larger principle balance of the new loan wouldn't come with increased basis, so eventually when / if the larger loan was repaid, the difference from the original principle would be interest.
Tanelorn
Posts: 2366
Joined: Thu May 01, 2014 9:35 pm

Re: Tax question personal loan

Post by Tanelorn »

ge1 wrote:Related to this a slightly different question: Can anybody think of a tax efficient way of making these loans? It's basically equivalent to holding a high yield bond fund in a taxable account, which isn't very tax efficient.
Maybe have your IRA make the loan, assuming you are actually going to be repaid? Lending Club will handle the logistics for this, although they take 1% off the interest rate for their fee and the max loan is $35k. Other P2P lenders might also offer something similar, and there are self-directed IRA custodians too for bigger accounts but those have lots of setup and ongoing fees.

https://www.lendingclub.com/public/indi ... nts.action
Longdog
Posts: 2173
Joined: Sun Feb 09, 2014 5:56 pm
Location: Philadelphia

Re: Tax question personal loan

Post by Longdog »

ge1 wrote:Thanks all for the feedback. Yes the rate is above the minimum IRS rates. Makes sense to me that the amount of interest earned rolled into the new loan would have to be declared as interest income.

Related to this a slightly different question: Can anybody think of a tax efficient way of making these loans? It's basically equivalent to holding a high yield bond fund in a taxable account, which isn't very tax efficient.
Mathematically equivalent, yes, but probably not as liquid as a high yield bond fund, and there is concentration risk since there is only one (or a very small number) of payers, as opposed to a diversified mutual fund that holds many such high-yield bonds.
Steve
Topic Author
ge1
Posts: 816
Joined: Sat Apr 28, 2012 8:15 pm

Re: Tax question personal loan

Post by ge1 »

Tanelorn wrote:
triskelion wrote:Unless you put out additional capital, the increase in capital would be interest paid. Make sure the rate charged is at least the IRS minimum to avoid imputed interest.

https://www.irs.gov/pub/irs-drop/rr-16-04.pdf
I don't see what in your link what addresses this point, aside from just giving the AFRs. Hopefully OP is charging considerably more than those!

You don't have constructive receipt of the interest unless you can actually get it, which is why it seems to me that a refinancing like this is more akin to accrued interest rather than a payment and reinvestment. If the lender really did pay him the money, he cashed the check into his bank, and then he re-loaned, I agree the interest would be paid and taxable as of that time. But if the borrower said, "well, I can't / don't want to pay now, but let's give you this bigger loan and I'll pay that off later, maybe", it's hard to argue you ever got paid (and might still never get paid). Certainly the larger principle balance of the new loan wouldn't come with increased basis, so eventually when / if the larger loan was repaid, the difference from the original principle would be interest.
Interesting perspective Tanelorn, need to think about that.
Post Reply