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Calling your P2P investments your own business?

Started by Peter, November 25, 2011, 11:00:00 PM

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Is this possible? Can one open a business solely for one's own investments into  Prosper's or LC's notes? I am most interested in it for the tax breaks. Does anyone have some insight on this?


I'm not an accountant or a lawyer, but I imagine you would have to treat it like any other business to escape the scrutiny of the IRS.  Separate bank account, phone numbers, tax filing etc etc.  It hurts when they decide its a hobby.  Many real estate investors learn that the hard way.


I have had a couple of emails from people who have created an LLC for the sole purpose of investing in Lending Club or Prosper. The official line from the legal people is that you cannot circumvent state laws by doing this. But it hasn't stopped some people from trying. You live in Texas, but create an LLC your business based in Delaware and boom you can invest in the retail platform.

As for doing it for the tax breaks that is a whole other question. I might have to chat with my accountant about that one. But Bilgefisher's comment is spot on - if you do everything by the book then I don't see why you couldn't create a business around it.
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Thank you for the replies, guys. Peter, please let me know what your accountant says. It would be a nice tax break for us that invest heavily into it. Thanks again.


It would make for an interesting post. I will try and reach out to get a couple of different opinions on the subject.


I'd like to chime in on this issue.  My background is in accounting. (Not actively practicing)

My short answer would be that as of right now, not even the IRS would be able to advise you if you can report P2P investments as a business.  Eventually, I assume someone will test this issue, and it will be resolved either by the Tax Court or IRS Opinion letter.

With that said, if we backtrack to the late 1990's and the stock market boom, and all the "day trader's" that came out of that, the IRS did make a distinctions between "investor" (reporting on Schedule B & D and deducted VERY LIMITED expenses on Schedule A) versus "self-employed trader" (reporting on Schedule C and deducting expenses directly).  But, they did not make it easy to be classified as a trader.  To do so, a trader had to show that trading was their primary business activity (not something they did while sitting at their desk at their primary job), there had to be significant trading activity (daily), AND the trader needed to attach a specially worded election to their tax return THE YEAR BEFORE they were considered traders, and finally, at the end of their tax year (generally 12/31), they needed to "mark to market" all their holdings--valuing their holding and reporting any increase or decrease in value, similar to if the asset was sold on that day. 

This was something that I assume began with a few test cases, that ended up in Tax Court, from which an Opinion, and Regulations were issued.

I do not see anything like this happening for at least a decade, until P2P goes very mainstream, but, I assume it would be advantageous for some of the larger investors (disclaimer: would depend on the investors other taxable income and deductions, of course).

The biggest benefit of being classified a "trader" was that in years that they had losses (ie capital losses), they could deduct them, in full, against other income, while "investors" are limited to $3000 per year of capital losses.  In P2P lending, charge-offs are reported as capital losses, so if a P2P investor does not have other capital gains, these charge-offs can only be deducted up to $3000 per year, while all the interest earned is report, in full, in the year paid.

Here's an example of the problem with the current taxation of P2P Investing:

Example: Assume interest earned during the year of $80,000, but charged-off notes were $33,000.  This investor earned $47,000 net, but would report net income of $77,000  ($80,000 income and a $3000 maximum annual capital loss), and pay taxes on $77,000.  If this person can report there P2P activity as a business, they would pay taxes on the $47,000, but would also potentially owe another 13-15% of Self Employment tax.  Generally, the latter option works out better for most.

And, here's a nightmare scenario:  Assume $50,000 interest, but lots of charge-off: $40,000.  Net earnings are $10,000, but net taxable income would be $47,000 and taxes on this could end up being HIGHER then this investor earned.


CA-lender, I appreciate the feedback on this. As you say there are no clear rules yet and some enterprising investors are going to push the envelope and we will get a ruling on this one day. But we are likely a few years off that.


Is there any reason we can't use a net figure as an individual? I'm invested only in $25.00 notes so I get no 1099's from LC. I should be able to take the net deposits and essentially mark to market at the end of the year to determine a profit or loss and be able to report the aggregate result to the IRS as benefits or losses from the investment. Since we are no longer buying individual notes and only actually getting an obligation from LC, doesn't it make it all one investment? (Ok--- I suppose this isn't how others are looking at it but it seems ridiculous to try and track hundreds of 25$ notes and the profit / loss on each individual note.)

Wouldn't the gain from LC be the aggregate sum not bunch of smaller profits and losses?

The taxation portion of LC seems very confusing and I have read up in several different places but just don't have a clear understanding of why it needs to be handled as individual units instead of a sum and difference in the taxable year?


The problem is there is clearcut way to do your taxes for Lending Club and Prosper. Consequently there are several schools of thought as to how you should file. Once the IRS audits someone some people and gives them feedback on what they would like to see we are simply going to be guessing. As long as you report your total net interest gained from Lending Club I don't see you getting into much trouble with the IRS.


I, too, am very interested in the possibility of creating an LLC or s-corp to get around the $3k max capital losses against regular income. (I live in California, which appears to limit the use of LLC to professionals like Lawyers, Accountants, and Architects, so I suspect an LLC may not be an option for me). Do we have any accountants out there that can offer an informal opinion about this? Unless something like this is possible, I'm going to have to greatly curtail my non-IRA investments in LC and Prosper, which would be a real pity.



To me I had a hard time clearly defining just what kind of business it would be.

Are we the lender: unsecured loan lenders or are we merely speculators: traders and the like? Each have their own requirements to operate that vary by state.

If we can create the business another VERY important thing to consider is solo 401ks and favorable self employment retirements plans to shift the p2p profit into and lower taxable liability.

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