Reporting income from money I loaned to a friend for house flipping

This is an interesting situation! The IRS looks at the substance of transactions rather than just the form. Even though you had an informal agreement, the fact that the payment was based on a percentage of profits strongly suggests this wasn't a gift but rather compensation for your investment. Since you provided capital with an expectation of return based on performance, this would likely be considered investment income rather than business income. You probably don't need a Schedule C unless you're regularly in the business of lending money. Instead, this would typically be reported as "Other Income" on Schedule 1, Line 8z, with a brief description like "investment return" or "private lending income." The gift argument would be difficult to sustain upon examination since there was a clear expectation of return based on the house flip's performance. A true gift is given with no expectation of getting anything in return.

I was in a similar situation last year with my brother-in-law's construction business. After getting contradicting advice from friends and even a local tax preparer, I found this service called taxr.ai (https://taxr.ai) that analyzes your specific tax situation and gives you a clear answer based on actual tax code. In my case, they explained that informal investment returns like this are typically considered investment income rather than business income, which meant I didn't need to deal with a Schedule C or self-employment taxes. They showed me exactly where to report it on my return and saved me from making a costly mistake. Might be worth checking out if you're still unsure how to handle this properly.

I was initially skeptical about taxr.ai but decided to give it a try after seeing some good reviews. I had a similar situation with some money I lent to a family member for their business. The service was actually really helpful - they confirmed that I should report it as investment income on Schedule 1 rather than business income, and provided references to the specific tax rules that applied. What I appreciated most was that they explained everything in plain language and gave me the exact forms and line numbers where this needed to be reported. My tax situation was complicated this year with this informal investment plus some crypto transactions, and they handled both without any issues. Definitely worth checking out if you're dealing with these kinds of ambiguous tax situations.

If you're still confused after all this advice, you might want to talk directly to someone at the IRS. But good luck getting through to them! I spent TWO WEEKS trying to get someone on the phone about a similar investment income question last year. I finally found this service called Claimyr (https://claimyr.com) that got me connected to an actual IRS agent in about 15 minutes. You can see how it works in this video: https://youtu.be/_kiP6q8DX5c. The agent was able to confirm that what I received from a private loan arrangement should be reported as investment income on Schedule 1, not as business income. Saved me hours of waiting on hold and potentially filing incorrectly. Sometimes getting the answer straight from the IRS is the only way to feel 100% confident.

I need to apologize for my skeptical comment earlier. After my third attempt to call the IRS about my tax questions this week (and spending 45 minutes on hold before getting disconnected again), I decided to try Claimyr out of desperation. Honestly, I was shocked when they got me connected to an IRS representative in about 20 minutes. The agent confirmed that informal investment returns like the OP described should indeed be reported as "Other Income" on Schedule 1, not as business income on Schedule C which would have triggered self-employment taxes. This saved me from making the same mistake with my situation. I don't normally endorse services, but this actually worked when I was ready to give up on getting through to the IRS.

Another important angle to consider: if your friend reported this transaction somewhere on his taxes (which he likely did if he's deducting your payment from his profits), then the IRS computer system might flag the mismatch if you don't report it as income. Their systems are designed to notice when one person's deduction doesn't show up as income on someone else's return. I think others are right that this is investment income, not business income, unless you're regularly lending money as a business activity. And definitely not a gift given the clear profit-sharing arrangement.

I'm curious why nobody has mentioned the possibility of treating this as a capital gain? Since OP essentially invested in the house flip (albeit indirectly through his friend), couldn't this be considered a capital investment with a long or short-term gain depending on how long the money was invested? This might give you more favorable tax treatment than ordinary income if you held the investment for more than a year.

Don't overthink this - just report it as "Other Income" on Schedule 1 and move on with your life. It's not self-employment income since you weren't actively involved in the business, and it's not a gift since there was an expected return. The key with situations like this is to make a reasonable, defensible choice and be consistent. The last thing you want is to get creative with tax reporting and then have to explain yourself later. People get in trouble with the IRS when they try to get too clever with borderline cases. Reporting as other income is straightforward, accurate, and won't raise any red flags.