If you live in the United States and invest in peer-to-peer loans via Lending Club or Prosper, there are tax implications that you should be aware of.

Lending Club Taxes

Lending Club will issue a 1099-OID form to investors for all Lending Club notes issued after October 24th, 2008. The calculation that Lending Club uses for the form is the interest payments and late fees that you have received as a borrower, minus the service fees that you pay as an investor. You will only get this form if you paid $10.00 or more in interest each year.

According to the book Wall Street Words, The 1099-OID form is used to report “the amount of implied and real income derived from original-issue discount securities such as Treasury bills, zero-coupon bonds, and commercial paper.” Income from a 1099-OID form must be included on Part 1 of Schedule D of your federal income tax return.

The income that you make from Lending Club is considered to be ordinary income, meaning that you will pay whatever your marginal tax rate is on your Lending Club investment. This does make investing in peer-to-peer lending a bit less attractive to those in higher tax brackets.

There are a few other 1099 forms that Lending Club will send out as well. You may receive a 1099-B form if you had sold notes on the FOLIOfn platform during the previous year. If you participated in any of Lending Club’s bonus offers, you will receive a 1099-MISC form if you received more than $600 in incentives. If you have any loans issued before October 14th, 2008, you will get a 1099-INT form from Lending Club, however, there are very few of those loans that remain outstanding.

Lending Club makes tax documents available by January 31st of each year. You can access your tax statements by going into your “Account Statements” section.

Lending Club also has a set of Frequently Asked Questions regarding tax matters.

Prosper Taxes

Investing in loans with Prosper.com has very similar tax implications to that of investing in loans with Prosper.com. Prosper.com will send out a 1099-OID form to investors that have invested in peer-to-peer loans on Prosper in 2009 or later. You will only get a 1099-OID from Prosper if you earn more than $10.00 in interest each year. The income you receive from Prosper is also considered to be ordinary income.

Prosper also sends out a few other 1099 forms. If you have notes dating back to before 2009, you will a 1099-INT form on your earnings. If you receive $600 or more a year in late fees and incentive payments from Prosper, you will get a 1099-MISC. There are some states that have reporting exemptions which would trigger a 1099 to be sent at a lesser amount. If you sell Prosper notes by way of FOLIOfn, you will receive a 1099-B form.

Prosper also has a “taxes” section under their Investing FAQ.

Defaults and Charge-Offs

As an investor, peer-to-peer loans that go into default can be considered investment losses. Lending Club simply reports written-off notes via year-end statements. Prosper sells some of its “bad debt” which can make tax matters a bit more complicated.

Prosper’s FAQ says the following about their treatment of charge-offs:

“Charge-offs and gross proceeds from any bad debt sale to a third party will be reported to investors in a year-end investor statement, and debt sales will be filed on tax form 1099-B. Using the loan principal balance before sale and the sale amount, investors can calculate their net amount of loss for the year. Investors are encouraged to consult their tax advisor to determine their tax basis on loans sold to debt buyers.Delinquent (late) loans which have not yet been sold to a debt buyer will have no impact upon taxes until further action on these loans takes place.”

Lending Club’s FAQ says the following about their treatment of charge-offs:

Lending Club notes that are written-off are reported on your year-end investor statement.

Avoiding Taxes with an IRA

Lending Club allows investors to open IRA accounts which allow lenders to invest in peer-to-peer loans in a tax advantage manner. You can read more about Lending Club’s IRA offering in our article, The Lending Club IRA: What You Need to Know.

Tax Implications and Investment Performance

When comparing peer-to-peer loans to other investments, such as stocks and bonds, you should consider the tax implications. Peer-to-peer loans are taxed as ordinary income and do not receive favorable capital gains rates. You could pay tax rates as low as 15% on stocks and mutual funds in which you experience a long term capital gain on, but your peer-to-peer loans could be taxed at 10%, 15%, 25%, 28%, 33% or 35% depending on your income level.

Disclaimer: I am not an accountant and do not offer tax advice. You should seek the counsel of an experienced accountant to answer specific tax questions.