Tax treatment of lending club

[lrosof]

I have read many articles about people unhappy with the tax treatment of lending club..  I am confused.  So if you put your money at Marcus you get 2.25 % and you receive a 1099-int and it is taxed as ordinary income. Lending club seems exactly the same except you get a return of roughly double plus you get capital losses. These losses can be used to offset capital gains in stocks.  Capital losses above $3,000 have value since they can be written off against stocks.  So my take is the tax treatment is the same as a savings account or CD, but the capital losses are a bonus and improves taxes through the 3k deduction and offset against stock capital gains.   Am I not looking at this the right way?  What am I missing?  I have not used LC platform yet but was considering doing so.

[Fred93]

So my take is the tax treatment is the same as a savings account or CD, but the capital losses are a bonus and improves taxes through the 3k deduction and offset against stock capital gains.   Am I not looking at this the right way?  What am I missing?  I have not used LC platform yet but was considering doing so.

No.  Capital losses are not a bonus.  They are losses.

So if you invest $1 in a loan, and the borrower pays as expected, you get your $1 back over time, plus you get interest.

But if you invest $1 and the borrower DOES NOT pay, then you do not interest, and you do not get your $1 back, ie it is confiscated, so you have a loss.

As  a consolation prize, you get to report that loss on your tax returns, so that it may decrease your taxes.  However, that loss may be either short-term or long-term depending on when the loan defaults.  If it is short-term, then it reduces your taxes the same way that interest increases your taxes, however if it is long term, then it decreases your taxes by a lesser amount, ie at the long-term capital gains rate.

This different tax treatment of interest vs losses is often what people are complaining about.

So sometimes people might say, well I make 10%/year interest on that loan, and only 5%/year of my loans default, so hey I'm makin' the equivalent of a 5% return (before taxes).

Unfortunately after taxes you would do worse than a 5% note with no defaults, because of the different tax treatments.

[storm]

I think you have a good grip on how LC is taxed.  Some things to think about:

• If you have a lot invested, the interest income can bump you into a higher tax bracket.
• If you have a lot invested and since LC does not withhold taxes, you can be in for a nasty surprise come tax season unless you adjust your W-4.
• If you invested in stocks/mutual funds/real estate instead and held on to it for over a year, you have the advantage of them being taxed at the more favorable long-term capital gains rate.
• I think the unhappiness really stems from a combination of having a large amount of write-offs (bad loans), little to no capital gains to offset, and having to roll over the losses into another year because of the $3k cap.