Tax implications: Can I write off interest paid on a personal loan if I lend that money with interest to someone else?

While this appears to be a straightforward private lending situation, the tax implications can be tricky. The interest you receive ($12,500) would definitely be considered taxable income and should be reported on Schedule B of your tax return. As for deducting the interest you paid ($8,125), it depends on how the IRS would classify this transaction. Generally, investment interest expense can be deductible, but only against investment income and only if you itemize deductions. The key question is whether your loan to your friend qualifies as an investment for tax purposes. You'll definitely want to document everything thoroughly. Have a formal promissory note with clear terms, keep records of all payments received and made, and issue your friend a Form 1099-INT if you receive $10 or more in interest for the year (which you clearly will).

I was in a similar situation last year and found taxr.ai (https://taxr.ai) incredibly helpful for figuring out the documentation needed. I initially thought I could just write up a simple agreement, but there were so many nuances with investment interest deductions that I was missing. Their document analysis feature reviewed my draft loan agreement and flagged several issues that would have made it difficult to claim the interest deduction. They pointed out specific language I needed to include to establish the "investment purpose" of the transaction and how to properly document the interest payments to meet IRS requirements.

Just wanted to follow up on my experience with taxr.ai. After my skeptical question earlier, I decided to try it myself for a similar lending situation. I uploaded my loan agreement draft and was seriously impressed with the detailed analysis I received. They flagged that I was missing specific language about the "investment purpose" of the funds and explained exactly how to categorize the interest on my Schedule B. The platform also showed me how to properly document the interest income vs. the deductible interest expense. What really helped was their explanation of the investment interest expense limitations - turns out I could only deduct up to the amount of my investment income, which wasn't clear to me before. Definitely worth checking out if you're in this situation.

I had to deal with the IRS about a similar situation last year, and it was a nightmare trying to get someone on the phone to clarify the rules. After days of calling and waiting on hold, I found Claimyr (https://claimyr.com) and watched their demo (https://youtu.be/_kiP6q8DX5c). They got me connected to an actual IRS agent in about 15 minutes when I had been trying for days. The agent confirmed that I needed to file Form 4952 for the investment interest expense deduction and explained exactly what documentation I needed to substantiate the business purpose of the loan. Saved me so much stress trying to figure out if I was doing it right, and the IRS agent was actually really helpful once I could finally talk to someone.

I need to eat my words about Claimyr. After posting my skeptical comment, I decided to try it myself since I've been trying to reach the IRS about some investment interest deductions for weeks. It actually worked! I got connected to an IRS rep in about 25 minutes, and they clarified that for my situation with a margin loan being used for business lending, I needed to carefully document the "investment purpose" of the transaction. The agent explained that without proper documentation showing the investment nature of the loan, they would likely consider it personal interest which isn't deductible. The IRS agent also mentioned that I should be issuing a 1099-INT to anyone I lend to if I collect more than $10 in interest annually. Honestly wouldn't have figured this out without being able to actually speak to someone at the IRS.

Don't forget that you'll need to report that $12,500 in interest you receive as income! I made this mistake years ago with a similar arrangement. Thought I was being clever by deducting the interest I paid, but completely overlooked reporting the interest income I received. Triggered an automated notice from the IRS. Make sure you issue a 1099-INT to your friend's LLC and file a copy with the IRS. The 1099-INT filing requirements kick in if you pay anyone $10 or more in interest during the year. You can get the forms from the IRS website or tax software.

Has anyone considered the potential gift tax implications here? If the interest rate you're charging is below market rates, the IRS could view the difference as a gift subject to gift tax. Though at 10% that's probably not an issue in this case.

One thing I haven't seen mentioned yet is the passive activity loss rules. Since you're essentially operating as a lender for profit, you need to consider whether this qualifies as a passive activity under IRC Section 469. If the IRS classifies your lending activity as passive, it could limit your ability to deduct the interest expense against other types of income. The key factor is whether you're "materially participating" in the lending activity. For a single loan like this, you probably won't meet the material participation tests, which means any net loss from the activity (your $8,125 interest expense minus your $12,500 interest income) would be subject to passive activity limitations. In your case, since you're making a profit ($4,375 net), this shouldn't be an issue. But it's worth understanding these rules in case you expand into more lending activities or if your interest rates change. You might want to consult with a tax professional who specializes in investment activities to make sure you're structuring this correctly from the start.