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Excuse the lack of terminology here.

A general contractor who is also a friend is seeking money to purchase, redo and then sell an existing home. He has about 85% of the total amount to purchase the home in cash, and so being a friend he asked me to help out.

He has written up a contract where for every dollar I provide to him now he will in 10 months time return my initial amount plus 18%.

I am unclear on how this income would be reported? Would this be considered capital gains? If I request he returns it to me in > 12 months time would then it be considered long term gains?

I have known him for a long time, he is very good at what he does and I am not interested in judgment calls on IF I should do this. I will determine that. I just need to know if it is actually worth the investment after taxes.

  • oops sorry, United States – treeNinja Sep 29 '14 at 21:17
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Assuming the United States. This is a loan and not an investment. You report this as income and will pay your tax rate on the 18% of the money that the borrower pays you (any money paid above what was originally lent) for the year in which it was received. You owe taxes on the income even if the borrower does not send you a Form 1099-INT showing the interest you received.

For example:

If you loan $10,000 and receive $1,800 in interest, and your tax bracket is 25%, then you will owe $450 in tax.

  • Even better if its considered a loan vs. an investment. – treeNinja Sep 29 '14 at 21:20
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    @treeNinja from tax perspective it is worse, since gains on investment are taxed at more favorable rates. But from legal perspective it is definitely better. – littleadv Sep 29 '14 at 21:36
  • @littleadv can you expand, why is it better from a legal perspective? Is this because an investment has much more risk and potential to go to zero while a loan indicates the ability to retrieve assets? – treeNinja Sep 29 '14 at 21:50
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    @treeNinja generally when you give a loan, the counter party is required to pay back regardless of whether the endeavor succeeds. With investment - you only share profits if there are any. – littleadv Sep 29 '14 at 21:55

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