I have been lending small amounts of money (hard money loans) to borrowers for real estate. I get interest payments. At the end of the year I get a 1099 INT which shows Interest received. The interest payments are in my personal name. I consider this a business. I have a lot of expenses like driving around to see the properties,(some are far away and need to fly to them), staying overnight at hotels, food, gas etc. I need to evaluate each property before loaning money. It is a risk reward evaluation. How do I deduct these expenses against the interest income?
Can I insert the Interest as income in a Sch C and deduct the expenses?
I suspect that you cannot consider your loans as a business unless you meet any state registration requirements as a loan originator. Without that, your loans are personal in nature and any expenses against them would, at best, be itemized deductions for the production of investment income.
I suspect there is more to this post than meets the eye. Unless these are commercial loans, it would be unusual to be receiving Forms 1099-INT for interest on private real estate loans, as they are also not required.
Similarly, driving around or flying around to see the properties, hotel costs, etc., would eliminate almost any profit on ?small amounts of money? lent to different borrowers.
More information would be helpful in recommending whether this could be a Schedule C business or not.
I don't see anything in the IRC or regs (though someone can prove me wrong) that requires compliance with state laws to be considered in a business, in the eyes of the IRC and IRS.
So, this to me seems to be a question of:
are you in a trade or business?
is you activity passive?
are your expenses ordinary and necessary?
are your expenses all or partly personal expenses?
According to IRS's Publication 334, "Interest received on loans is business income if you are in the business of lending money," which is totally circular and totally useless.
Are you really getting a 1099-INT from individual borrowers? Are you asking the borrowers to send that form to the IRS and to you?
The IRC doesn't require compliance with state laws to be considered a business, but if the activity is illegal, the ability to deduct expenses is severely limited.
My broker periodically sends me opportunities for lending. I evaluate each one of them separately when I receive them and do the due diligence which requires out of pocket expenses before lending the funds.
I co-lend with other lenders in a single loan. That is why my portion is not the entire loan.
The broker sends me a 1099 INT at the end of the year for all the interest received by me thru his company. His company does all the collection of monies from the different borrowers and sends me my portion of the interest periodically. The total amount lent by me during the year would be spread over several loans.
My question is Can I report the Interest in Sch C as income and deduct my legitimate expenses in Sch C? or is there some other way to accomplish what I am trying to do?
You have another hurdle to overcome - business vs. hobby activity. As I alluded to earlier, your idea of "small amounts" may be very different from mine. In my mind, your expenses are probably equal to or greater than your income from these "small" loans. If so, and you can't show a profit in 3 out of 5 years, the IRS can determine that you have a hobby activity. Expenses for a hobby activity are limited to the amount of income, but are deducted as Schedule A miscellaneous itemized deductions subject to a 2% AGI haircut, not Schedule C expenses.
This sounds like the people that want to buy a few shares in a publicly traded stock, and then write off their boondoggle trip to the annual meetings hither and yon. No can do.
An LLC is not "automatically" a business. Since an SMLLC is a disregarded entity to the IRS, you still have to meet all of the same requirements as you would without the LLC.
Unfortunately the answer to your question is highly fact based, and you have not included nearly enough facts. The issues are whether this would be considered a "hobby" by the IRS, or whether it might be considered a passive activity.
You really need to talk to your own tax preparation professional (CPA or Enrolled Agent), who can ask you all the necessary questions and look into all the facts to help determine where you fit. If you don't have a tax pro and you are in business, you really need to find one, or you could end up unnecessarily losing a lot of money either in overpaid taxes or penalties.
I concur with the other posters. You _might_ have a business if (1) You can rationally expect to make a profit. (As you say you lend _small_ amounts of money, your expenses to visit a property must be less than your expected revenue from that property; once you get an idea of your acceptance rate, your expenses must be less than expected revenue times the acceptance rate.) "Rationally" and "reasonably" are not part of the regulation, only "honestly", but, since you are asking.... (2) On each trip, you must spend significantly more time with the properties than on personal sightseeing. (3) You must run it as a business.
In general you can deduct "ordinary and necessary" expenses for a business.
"Ordinary" means others in your business do those things, and "necessary" means, that expect a larger net profit from doing those things.
There's also "business v. hobby"; if a hobby, there's no Schedule C, and "ordinary and necessary" expenses can be deducted, as a miscellaneous itemized deduction subject to the 2% limit.
And also "active v. passive"; if a business and passive, you can deduct "ordinary and necessary" expenses up to the amount of income, with carryforward.
Finally, and possibly legitimately, subject to conditions (1) and (2) above, you might be able to deduct them as investment expenses; deductible, up to the amount of income, as a miscellaneous itemized deduction subject to the 2% limit, with carryforward. You would still have a lot of work to document the reasonableness of the expenses. The deduction and carryforward appear to be on a per-property basis; expenses related to a property in which you do not invest are lost.
Seriously, why not use Google Earth to look at properties?
I think if this or any other activity qualifies as a business, deductions would not be "investment expenses" but would be business deductions, not subject to any limit (other than passive activity loss limitations, if applicable). And as a business, expenses related to looking at properties not invested in would also be deductible, as that is part of the business.
I don't know what "small amounts of money" is, but in my mind higher amounts of money would be more apt to result in this being a business activity rather than an investing activity. And with more money at stake, Google Earth would not suffice for prudent due diligence.
It seems that OP is investing in LP units or something, with the bundler doing the due diligence, reporting, etc. Sounds like investing activity.
The total amount invested is about 650k over many loans. 20k to 50k per loan. Quite often, the loans are paid off (early payoff) or come to maturity. So I seek another loan to place the principal received. So the cycle of due diligence starts all over again.
This is a not a hobby for me. I am depending on this income very much. Considering the due diligence and out of pocket money expenses spent, I do not consider this as a passive activity. Besides the upfront due diligence I even have to monitor and calculate if the interest I am receiving is correct and arriving on time and that there are hopefully no delinquencies.
Hope this helps.
Again, your thoughts would be very helpful as to whether I can input the interest received as Income in Sch C and then deduct the legit expenses.
If so, do I need to write a cover letter to the IRS when I file my next Tax return explaining why and how I have treated this Interest received via 1099-INT?
You may well have a "business" and be able to deduct your expenses on Schedule C. However, again, the devil is in the details. And no matter what you tell us here, there are bound to be things missing. You really need to talk to your own tax preparation professional, who can fully analyze your situations, and advise you on whether anything needs to change to optimize your chances.
If you qualify to file a Schedule C, then just do that. If they have questions they will let you know.
Let's assume someone is such a situation does qualify to file a Schedule C for this business. Where is the interest income posted - to Schedule C, not Schedule A? And does this mean the net from this business is subject to SE tax? And not the 3.8% Net Investment Income Tax?
Taxed & Spent asks us, above: "And does this mean the net from this business is subject to SE tax? And not the 3.8% Net Investment Income Tax?"
Two very good questions, Taxed & Spent. Or maybe it's really just one question...
Lisa: Please *do not* write a cover letter to the IRS. The goal here is to file what you need to, and to have the IRS accept it without making a big to-do over it, isn't it?
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