Tax Implications of Social Lending

First of all, what is Social Lending? Social lending is person to person (sometimes referred to as "peer to peer") lending. With our economic times being what they are, at least a dozen social lending sites have cropped up on the Internet where borrowers and lenders are introduced. For borrowers the advantage is paying less interest than banks charge and for the lender the advantage is a better short term return than a large institution can offer. So it would appear that everyone wins.

For the lender, the tax implications are quite simple. As long as the lender secured a valid note (which is most important - without one the IRS could claim that the loan was nothing more than a gift, which is the last thing the lender wants, particularly if the loan should go bad) the lender is required to report the interest received as income. Obviously then, the interest income is taxable.

However, for the borrower the rules are not as simple. Determining whether the interest is deductible or not depends largely on how the money is used. For example if the monies borrowed is used for nothing more than to pay personal debts, the interest is nothing more than non-deductible personal interest. If, on the other hand, the monies borrowed are used to pay, for example, business expenses, the appropriate amount could be deducted as a business expense. So for the borrower the tax implications can become quite complex. Be sure to do your research before you borrow to understand exactly what you are getting into.