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Not worth the returns after taxes.

Started by Peter, April 12, 2017, 11:00:00 PM

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nonentity

Is there a flaw in what I'm doing?

Say you are in the highest tax bracket and you earned 1,000,000 in total interest in your 1099 oid, but you have 400,000 of charge offs. So you have 600,000 net gain for the year.

But you have to pay 50 percent taxes (federal and CA state) on 1,000,000 due to your tax bracket. Now you owe 500,000 and you actually make 100,000 on 1,000,000 interest after taxes and charge offs.

So if you had 8 percent return on a 12.5 million account which earned 1,000,000 in interest but you actually net 100,000, your true return after taxes and charge offs is 0.8 percent.

Of course you can take the 400,000 charge offs as a capital loss, but assume you didn't take any capital gains in 2014.


Now in my personal account the oid interest is 8,000 and my losses is 3,000. My net gain is 5000 but I pay taxes on the 8000.  In my 34 percent tax bracket that means I have to pay 2720 on 8000, which means after taxes and charge offs my net gain is 2280. This makes it feel like a 54.4 percent tax rate on the 5000 net gain.  If I only had to pay 34% on the 5000 I would have to pay 1700, 1000 less than what I actually owe.

Not worth it. After 3+ years I'm withdrawing my lending club funds and not going to reinvest. Once the charge offs start piling up and eating into your interest, taxes end up killing your gains.

stanny2

Wouldn't the 3,000 in losses be a capital loss, above the line deduction? That would then lower your tax burden $1,020 @34%...not a CPA, so can't say this is correct.





Lovinglifestyle

This issue ($3,000 limit, rising losses, declining life span) concerns me also.  I'm putting additional investment on hold while I watch what happens to the lates I no longer want to sell at deep discounts.  2013 and 2014 were/are both over the 3K limit and I have no offsetting gain.

mchu168

I live in CA and pay 50%+ incremental taxes on investment income too.  You are right that the after tax returns are unattractive/too low. Munis offer better risk/reward for taxable funds, imo.  I also like some of the leveraged corporate bond CEFs for yield.

I stopped investing in P2P loans with taxable money.  I'm only investing IRA money now.   Once I retire and move out of CA, I will probably start putting taxable money back into P2P loans.

Theta

Yes, this is a problem for taxable accounts.   I think a work around might be to do the investment though a fund.  There was a report that LC was going to set up a public closed end fund for their loans so people could easily invest.  If they did that then the CEF would be subject to SEC rules Investment Company Act of 1940 and could offset the losses from gains.  At lease I think so.  I haven't heard anything about the LC CEF since it was initially mentioned in 2013.

kya

i hate to say it but my lc and prosper accounts are just a "hobby" a cef muni fund like men, mmu or vki three of over a hundred make better sense..also sell at a discount to net asset value

AnilG

Are you all only investing in P2P lending and not in other investments such as mutual funds, ETF, and stocks? The statement of no capital gains from other investments to offset against capital losses from P2P lending makes me concerned that may be people are not diversified across different investment asset classes.

If last year you didn't generate enough capital gains from other investments to offset capital losses from P2P lending, your portfolio might be unbalanced. P2P lending is still a young untested unproven asset class and shouldn't be more than tiny bit of your total portfolio.

Capital gains is taxed at 15% and interest income is taxed at your ordinary income tax rate. If your effective ordinary income tax rate is higher than 15%, it makes sense to convert some of the interest income into capital gains by selling the notes on secondary market at premium.

TravelingPennies

I have a buy and hold strategy, so I have almost no capital gains.  Also, capital gains are now taxed at 20% in higher tax brackets.  Add on top of that an 11%+ CA state tax and the Obamacare 3.8% surcharge, and it makes sense to never sell anything in a diversified portfolio.... never, ever.


jpildis

I highly recommend that you research the IRS rules for Contingent Payment Debt Instruments... if you look at the definition of CPDIs and the structure of LC investments, one can make a strong argument that LC notes are, indeed, CPDIs.  If you come to that conclusion, capital gains and losses are treated as normal income and will either add or subtract from your OID income.

This is not tax advice and you should always discuss matters like this with a tax professional.


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