The April 18, 2017 tax deadline also marks your last chance to fund a new traditional IRA or Roth IRA for 2016. Both Lending Club and Prosper allow you to open up retirement accounts. You can also transfer money from an existing IRA to either company which can be done at any time. In this post I’ll share why it is most efficient to invest in p2p lending through a tax advantaged account and the basics of what Lending Club and Prosper offer. If you’re interested in learning about how to file taxes with Lending Club and Prosper investments you can review our recent tax post.
Lending Club and Prosper investments are different from investing in stocks. Borrowers repay monthly and this income is taxed at the same tax rate as your ordinary income. The losses or charge offs from loans are capital losses. Investors are able to deduct $3,000 a year of capital losses (Federal). Any losses over $3,000 are carried over to future years. There also may be a limit in capital losses you can claim each year at the state level.
Where I live in Wisconsin there is a $500 limit on the Wisconsin deduction for capital losses. While I remained below the $3,000 federal limit, I now am carrying over losses on the state level year after year since I invest through a taxable account. Capital losses first offset capital gains. With no capital gains, the losses will be deducted from ordinary income.
Depending on your ordinary income tax rate, your capital losses may be offset first by long-term gains that have more favorable tax treatment, usually 15% (depending on your income), as opposed to your potentially higher ordinary income tax rate. Short-term gains on the other hand have a higher tax rate, similar to the ordinary income tax rates (see Capital gains tax in the U.S.).
Lending Club shares the contrast of investing through a tax deferred account versus a taxable account: