Author Topic: Not worth the returns after taxes.  (Read 23186 times)

nonentity

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Not worth the returns after taxes.
« on: February 11, 2015, 12:38:08 PM »
Is there a flaw in what I'm doing?

Say you are in the highest tax bracket and you earned 1,000,000 in total interest in your 1099 oid, but you have 400,000 of charge offs. So you have 600,000 net gain for the year.

But you have to pay 50 percent taxes (federal and CA state) on 1,000,000 due to your tax bracket. Now you owe 500,000 and you actually make 100,000 on 1,000,000 interest after taxes and charge offs.

So if you had 8 percent return on a 12.5 million account which earned 1,000,000 in interest but you actually net 100,000, your true return after taxes and charge offs is 0.8 percent.

Of course you can take the 400,000 charge offs as a capital loss, but assume you didn't take any capital gains in 2014.


Now in my personal account the oid interest is 8,000 and my losses is 3,000. My net gain is 5000 but I pay taxes on the 8000.  In my 34 percent tax bracket that means I have to pay 2720 on 8000, which means after taxes and charge offs my net gain is 2280. This makes it feel like a 54.4 percent tax rate on the 5000 net gain.  If I only had to pay 34% on the 5000 I would have to pay 1700, 1000 less than what I actually owe.

Not worth it. After 3+ years I'm withdrawing my lending club funds and not going to reinvest. Once the charge offs start piling up and eating into your interest, taxes end up killing your gains.

stanny2

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Re: Not worth the returns after taxes.
« Reply #1 on: February 11, 2015, 12:53:32 PM »
Wouldn't the 3,000 in losses be a capital loss, above the line deduction? That would then lower your tax burden $1,020 @34%...not a CPA, so can't say this is correct.

Fred93

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Re: Not worth the returns after taxes.
« Reply #2 on: February 11, 2015, 12:54:10 PM »
in my personal account the oid interest is 8,000 and my losses is 3,000.

What are you doing that makes your losses so darn high?  That's one problem. 

Quote
My net gain is 5000 but I pay taxes on the 8000.

That's not right.  You should be writing off the losses, so that at the end you're paying tax on the 5000.

nonentity

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Re: Not worth the returns after taxes.
« Reply #3 on: February 11, 2015, 01:00:56 PM »
in my personal account the oid interest is 8,000 and my losses is 3,000.

What are you doing that makes your losses so darn high?  That's one problem. 

Quote
My net gain is 5000 but I pay taxes on the 8000.

That's not right.  You should be writing off the losses, so that at the end you're paying tax on the 5000.

Yes, the 3000 is a capital loss, and I used that to offset my capital gains and I could use that to offset my interest income up to 3000 also like you said if I had no capital gains. But the issue still remains, once you reach over the 3000 limit you can't take the more than a 3000 loss against interest income. Once your losses pile up which it eventually will in mature accounts, it feels like the tax burden increase while your gains decrease.

Fred93

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Re: Not worth the returns after taxes.
« Reply #4 on: February 11, 2015, 01:22:55 PM »
But the issue still remains, once you reach over the 3000 limit you can't take the more than a 3000 loss against interest income.

Ok, so it is really the 3000 limit that bothers you.  Most people have some capital gains from stock market investments, which makes this not a problem.  In any case, you don't lose the capital loss over the 3000.  It rolls forward to the next year. 

The 3000 limit is a stupid feature of the tax code.

You didn't answer why you have such large losses.

nonentity

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Re: Not worth the returns after taxes.
« Reply #5 on: February 11, 2015, 01:45:05 PM »
But the issue still remains, once you reach over the 3000 limit you can't take the more than a 3000 loss against interest income.

Ok, so it is really the 3000 limit that bothers you.  Most people have some capital gains from stock market investments, which makes this not a problem.  In any case, you don't lose the capital loss over the 3000.  It rolls forward to the next year. 

The 3000 limit is a stupid feature of the tax code.

You didn't answer why you have such large losses.

I don't think they are such large losses. My adjusted NAR is 8.06 for an $87000 account almost 4 years old.


Yes, the limit is the problem. If you could subtract the charge offs of any amount against the interest  then everything would be fine and dandy, but you can't and have to pay taxes on the full interest earned even if you only net 60 percent of it. For large accounts, this is a huge problem like I gave the example above.  It's just something I feel makes it not worth doing anymore. I'll just stick to dividend etfs for passive income.



Lovinglifestyle

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Re: Not worth the returns after taxes.
« Reply #6 on: February 11, 2015, 03:37:57 PM »
This issue ($3,000 limit, rising losses, declining life span) concerns me also.  I'm putting additional investment on hold while I watch what happens to the lates I no longer want to sell at deep discounts.  2013 and 2014 were/are both over the 3K limit and I have no offsetting gain.
« Last Edit: February 12, 2015, 12:03:23 AM by Lovinglifestyle »

mchu168

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Re: Not worth the returns after taxes.
« Reply #7 on: February 11, 2015, 04:06:54 PM »
I live in CA and pay 50%+ incremental taxes on investment income too.  You are right that the after tax returns are unattractive/too low. Munis offer better risk/reward for taxable funds, imo.  I also like some of the leveraged corporate bond CEFs for yield.

I stopped investing in P2P loans with taxable money.  I'm only investing IRA money now.   Once I retire and move out of CA, I will probably start putting taxable money back into P2P loans.

Theta

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Re: Not worth the returns after taxes.
« Reply #8 on: February 11, 2015, 04:29:25 PM »
Yes, this is a problem for taxable accounts.   I think a work around might be to do the investment though a fund.  There was a report that LC was going to set up a public closed end fund for their loans so people could easily invest.  If they did that then the CEF would be subject to SEC rules Investment Company Act of 1940 and could offset the losses from gains.  At lease I think so.  I haven't heard anything about the LC CEF since it was initially mentioned in 2013.

kya

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Re: Not worth the returns after taxes.
« Reply #9 on: February 11, 2015, 07:47:11 PM »
i hate to say it but my lc and prosper accounts are just a "hobby" a cef muni fund like men, mmu or vki three of over a hundred make better sense..also sell at a discount to net asset value

AnilG

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Re: Not worth the returns after taxes.
« Reply #10 on: February 11, 2015, 08:55:02 PM »
Are you all only investing in P2P lending and not in other investments such as mutual funds, ETF, and stocks? The statement of no capital gains from other investments to offset against capital losses from P2P lending makes me concerned that may be people are not diversified across different investment asset classes.

If last year you didn't generate enough capital gains from other investments to offset capital losses from P2P lending, your portfolio might be unbalanced. P2P lending is still a young untested unproven asset class and shouldn't be more than tiny bit of your total portfolio.

Capital gains is taxed at 15% and interest income is taxed at your ordinary income tax rate. If your effective ordinary income tax rate is higher than 15%, it makes sense to convert some of the interest income into capital gains by selling the notes on secondary market at premium.
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mchu168

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Re: Not worth the returns after taxes.
« Reply #11 on: February 11, 2015, 10:57:04 PM »
I have a buy and hold strategy, so I have almost no capital gains.  Also, capital gains are now taxed at 20% in higher tax brackets.  Add on top of that an 11%+ CA state tax and the Obamacare 3.8% surcharge, and it makes sense to never sell anything in a diversified portfolio.... never, ever.

lascott

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Re: Not worth the returns after taxes living in CA and very high income.
« Reply #12 on: February 11, 2015, 11:51:11 PM »
I have a buy and hold strategy, so I have almost no capital gains.  Also, capital gains are now taxed at 20% in higher tax brackets.  Add on top of that an 11%+ CA state tax and the Obamacare 3.8% surcharge, and it makes sense to never sell anything in a diversified portfolio.... never, ever.

Little perspective here for everyone reading this thread.  This is only an issue for a small percentage of people in certain states and with very high incomes (39%+11% taxes). Not the typical retail investor.


http://www.schwab.com/public/schwab/nn/articles/Taxes-Whats-New
« Last Edit: February 11, 2015, 11:53:00 PM by lascott »
Tools I use: (main) BlueVestment: https://www.bluevestment.com/app/pricing + https://www.interestradar.com/ , (others) Lending Robot referral link: https://www.lendingrobot.com/ref/scott473/  & Peercube referral code: DFVA9Y

jpildis

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Re: Not worth the returns after taxes.
« Reply #13 on: February 12, 2015, 10:27:23 AM »
I highly recommend that you research the IRS rules for Contingent Payment Debt Instruments... if you look at the definition of CPDIs and the structure of LC investments, one can make a strong argument that LC notes are, indeed, CPDIs.  If you come to that conclusion, capital gains and losses are treated as normal income and will either add or subtract from your OID income.

This is not tax advice and you should always discuss matters like this with a tax professional.

BruiserB

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Re: Not worth the returns after taxes.
« Reply #14 on: February 12, 2015, 12:19:39 PM »
I highly recommend that you research the IRS rules for Contingent Payment Debt Instruments... if you look at the definition of CPDIs and the structure of LC investments, one can make a strong argument that LC notes are, indeed, CPDIs.  If you come to that conclusion, capital gains and losses are treated as normal income and will either add or subtract from your OID income.

This is not tax advice and you should always discuss matters like this with a tax professional.

There was a post in the forums a couple of years ago regarding this by AmCap.  I'm not sure if he's still active here.

http://www.lendacademy.com/forum/index.php?topic=805.0

There he said:

Quote
Per Code Section 166, non business bad debts are treated as short term capital losses, regardless of how long you've held the debt instrument.  See generally, http://www.fool.com/school/taxes/2000/taxes000107.htm
for why that matters.  If you have net short-term capital loss, you can deduct against ordinary income up to $3k per year.
 
Note that the mandatory short-term rule only applies to losses, not to gains.  If you buy a note, hold it for a year, and sell for a gain over your adjusted basis, you get long-term capital gain (yippee!).

So he seemed to argue that any losses should be taken as short term losses (therefore at your normal marginal rate) but still subject to a maximum $3000 yearly loss after offsetting any gains.  I've also seen this CPDI argument, which sounds completely reasonable.  And then starting with last year I get the Lending Club Tax Guide with my 1099 which tells me to take notes held less than a year as short term losses and notes held more than a year as long term losses. 

Bottom line, there seems to be no consistent recommendation of what to do.  It would certainly be to LendingClub's advantage to be proponents of the CPDI approach as it would simply allow investors to deduct losses from our OID income and give the best possible tax treatment to the losses.  Why don't they do this?  There must be some reason they feel that their notes don't qualify as CPDIs.....even though your argument that they should seems equally reasonable to me.

I wouldn't mind being more aggressive in declaring my losses.  As I understand it, if you make a mistake in good faith and are audited you will simply pay the corrected tax amount and maybe some interest, but won't be penalized.  But if I were to consider my losses as losses on CPDIs, how would I show that on my taxes?  I can't simply reduce my OID income by the loss amount, or things won't match up when the IRS compares my declared interest vs what's been reported to them on 1099s.  Is there a specific line one would enter this loss on?  And more specifically, what Turbo-Tax question would I answer so that it asks me for my CPDI losses?