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If I make a $1000 investment in peer-to-peer lending, then are the repayments simply taxed as interest payments, similarly to interest earned in a savings account, or is there a reflection of the cost basis like you have when investing in stocks or ETFs?

For example, if I were to invest $1000 in a stock then sell it within the same year for $1200, I would only pay capital gains taxes on the $200 profit. If the loan repayments for a single year total $400 (assuming a 3-year loan that would repay $1200 overall with equal payments), do I pay taxes on all $400 or is there an adjusted cost basis of $333 (or something) so I'd only pay taxes on $67 of the original $400 repayment?

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2 Answers 2

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You should receive tax forms such as 1099-OID (for interest) and 1099-B (for charge-offs). Apparently, in contrast to traditional bonds with "coupon" interest payments reported on 1099-INT and principal returned at maturity, many peer-to-peer loans are structured as debt that you purchase at a discount. In your example, you bought $1200 of debt for $1000. The difference would be considered income in the form of an "original issue discount" of $200, and would be amortized over the loan term.

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  • I see, so taxes are only due on the discount, not the entire repayment. Out of curiosity, do you know if there is an IRS publication covering this? I haven't seen one, but I might have the wrong search terms. The link you provided is very helpful!
    – Hari
    Jun 10, 2018 at 23:40
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    @HariGanti There is a section of Pub 550 on original issue discount.
    – nanoman
    Jun 10, 2018 at 23:47
  • It seems OID might not apply because of exception 5. Am I wrong in how I'm reading it?
    – Hari
    Jun 11, 2018 at 4:03
  • @HariGanti That's beyond my knowledge. I suspect it may matter that the loans are handled through an intermediary organization rather than directly between individuals.
    – nanoman
    Jun 11, 2018 at 4:45
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    @Hari, those exceptions are relevant in the case where no interest payments are made on the loan for over a year. In the example given in your question, regular payments are being made, so the interest income is taxed as it is received.
    – prl
    Jun 11, 2018 at 16:16
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The peer-to-peer lending platform will send you a form 1099-OID listing the amount of interest that you were paid that year. From IRS publication 550: "OID is a form of interest. You generally include OID in your income as it accrues over the term of the debt instrument, whether or not you receive any payments from the issuer." I've been adding the 1099-OID box 1 amount into the "Interest" line on my form 1040.

You'll also lose some money due to charge-offs, which are listed on form 1099-B as "Proceeds" (1d) from the sale of notes that went bad, and the "Cost or other basis" (1e) that you originally paid for those notes. Your Basis is almost always bigger than the Proceeds, making the 1099-B a net capital loss (that is, you lost money on those bad debts). Rules for handling capital gains and losses are incredibly complex, but even if I don't have any capital gains that year, I seem to be able to write off up to $3,000 of capital losses (equal to Basis minus Proceeds) on my form 1040 just by filing Schedule D.

The IRS doesn't seem to want to know the total value of notes that you hold (including principal repayments) just the change in value of those notes due to interest and charge-offs.

Disclaimer: I am absolutely not a tax professional. The US tax code is among the most complex entities ever designed.

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