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I've invested some small amount of money in LendingClub notes. I wrote about it in my blog, if anyone is interested. Overall it seems to be working great, I spread my investment over a broad variety of loans with various ratings, and have (in theory) a pretty nice >10% ROI.

However, one of the debtors defaulted on his loan, in which I had interest. The loan has been charged off by LendingClub. My current portion of the principle is ~$22.

Now, the amount is small, but the question still stands: how does it affect me, especially tax-wise? Can I deduct these 22 dollars on my taxes this year as a short-term loss? (note was issued in march this year) What if it gets collected in a year from now and I get some or all the money?

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    This'll be my first year of taxes while in Lending Club but i suspect their tax documents will give some clue based on the forms they send but it's still a great question. – nicerobot Dec 13 '11 at 0:24
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    From reading the prospectus and a relevant FAQ, it appears that the note corresponding to the charged off loan should be considered a worthless security. As such, you would treat the $22 as a short term capital loss. If this were a conventional direct loan, it would be treated the same, but with the prospect of subsequent loan repayment being treated as ordinary income up to an equal amount of the write-off deduction. I lack expertise to offer this as an answer – clfenwi Dec 13 '11 at 17:10
  • I would expect that the losses would offset any gains first you you would claim your net gain as income (unless it meets capitol gains standards). In theory, in the event of recovery you should revise the taxes you filed originally amending the loss amount. If you have an auditor feeling generous they may allow you to claim it as gains on the year where the recovery was made but I try not to rely on the generosity of the IRS to accept my legal deductions as they should be and claim them how the IRS Prefers them. – user4127 Dec 14 '11 at 14:32
  • @Chad - why would I need to append? Can you provide references? – littleadv Dec 14 '11 at 18:46
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    If you sold your $22 interest to someone (even for $0.01) then you could write off the investment as a capital loss and never worry about having a future unexpected gain. I've known people to do this with stocks that they owned when the company went bankrupt. – Alex B Dec 15 '11 at 4:07
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Once a note has been fully charged off, not just late or in collection, it's remaining principal can be deducted as a loss. You'll still be taxed on the OID interest you received from the loan before the loss. Also, any loans sold on the secondary market they offer for a loss, you can deduct the loss amount.

If there is any recovery in a later year, which is possible even in charge off as the debt has likely been sold to collections agencies with a return % provision sometimes (not sure of lending club's specific provisions, so you might want to ask), then you'd have to file an amended return to adjust for the recovered amount and pay the taxes owed as a result of the change in your total itemized deductions.

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