Author Topic: Contemplating P2P as a Business for Tax Purposes  (Read 5927 times)

severancejoan

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Re: Contemplating P2P as a Business for Tax Purposes
« Reply #15 on: February 11, 2019, 06:42:48 AM »
Sure!  For any property, your gain or loss for tax purposes is the amount you receive when you sell the property minus your adjusted basis in the property.  Your adjusted basis is generally what you paid for it, plus or minus various adjustments.  For a debt instrument w/ OID, your adjusted basis is increased by the OID as it accrues, and is decreased by payments of interest and principal other than qualified stated interest.

Let me explain by hypothetical.  Let's say you bought a financial instrument for $100 dollars today, and it matured in 5 years.  You get no payments during the 5 years, just a final payment of $150 5 years from now.

From an intuitive level the tax is simple enough, you'd pay capital gains tax on the $50 of gain when you sold the instrument at maturity.  $150 on sale, minus $100 of cost basis.

All that basis does is measure the capital investment you have in property that should be returned to you tax free when you sell the property.  In the prior example, the $100 basis is what you shouldn't have to pay tax on because it is just return of your capital.

Now take the same instrument, but add in a rule that says that when you buy a financial product with a defined gain and maturity, you have to pay tax on that gain equally over the life of the instrument.  So, let's just say that the tax man makes you pay tax on the $50 of gain at a rate of $10 per year, regardless of when you get the cash. 

When you finally get to maturity and the instrument pays you back the $150, you certainly wouldn't feel that you should pay capital gains tax on the $50. You already paid tax on it!  That is what I mean when I say that you have to adjust your basis to account for OID.  OID says that when you buy a debt instrument at a discount, you include and pay tax on OID over the life of the instrument.  To make sure that you don't double count your gain upon a sale or disposition, your basis has to be adjusted upward by the amount of OID.  If you actually get paid any principal and non-qualified stated interest, then your basis has to be adjusted back down to reflect that you actually received the money you're being taxed on.

Ok, keeping with the example...a $100 instrument that makes no payments and matures with a payout of $150 bucks.  Let's also assume that you have to include OID of $10 per year.  Now let's say at the end of year 3, the instrument becomes worthless.  Worthlessness is considered a sale or disposition; basically you are treated as though you sold it for $0.  You might say, ok I should get to deduct $100 because that is my cost basis.  But that's not right, because in addition to the $100 you lost, you paid tax on $30 of OID but never got the cash.  So, you should also get to take a deduction for the $30 because you paid tax on it, but never received any money.  In this situation, if you don't adjust your basis, you'll just give away the tax you paid on the $30. 

The OID you pay is interest income, which is taxed at ordinary rates.  But, the basis adjustment essentially turns that ordinary income into basis in a capital asset.  Because the OID you payed tax on is wrapped into your basis in a capital asset, you pay tax on the income at ordinary rates, but have to take the loss as a capital loss.

WHY IS IT A CAPITAL ASSET/LOSS?

I THINK IT'S BS THAT INTEREST IS TAXED AS INCOME BUT CHARGE OFFS ARE TREATED AS CAPITAL LOSSES.

severancejoan

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Re: Contemplating P2P as a Business for Tax Purposes
« Reply #16 on: February 11, 2019, 06:44:12 AM »
Another question.

Since Capital losses are capped at $3,000 per year, this makes a taxable P2P account get pretty unattractive as it gets larger. I'm already  rolling over losses that could make it impossible to write off the losses in anywhere close to the investment term.

It seems more appropriate to match the losses with the income, and then pay taxes on the profit. Has anyone done it this way?

Graceful

YES

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