EXPLAINED: 1098s and 1099s for private lenders

[Michael Plaks]

This is one of those confusing tax issues that does not have a short answer: do I need to send Forms 1099-INT to my private lenders, and do they need to send me Forms 1098?

Part 1: Forms 1098 from private lenders to investors

This is the form that you receive from conventional mortgage lenders. It tells you how much interest you paid on your mortgages. It also tells the IRS how much interest you can claim as a deduction. The IRS computer will match your 1098s against your deductions. If you claimed more in interest deductions than what your Forms 1098s say, the IRS might get suspicious and send you a letter asking for an explanation. They may even start an actual audit of your tax return.

What about private lenders then? Are they required to send you 1098s, just like traditional mortgage lenders? Yes, they are, but only IF they check all 4 boxes:

1. The private lender runs "a trade or business", like hard money lenders and professional money lenders do, as opposed to a casual lender such as a friend or a family member.

2. The loan is issued to an individual or a disregarded single-member LLC, as opposed to loans issued to partnerships or corporations.

3. The loan is a mortgage, i.e. it is secured by real property.

4. The annual interest paid on this mortgage was $600 or more for the prior year.

As you can see, these conditions are not totally clear and leave some room for interpretation, especially the "trade or business" clause. As a result of this confusion and, more importantly, simply not knowing these rules (or knowing but ignoring them), investors never know if they will receive a 1098 from their private lender. Many hard money lenders send 1098s, others don't. Private lenders are a roll of a die.

What happens if you do not receive a 1098? Not much. You are still legally entitled to claim the interest you paid as a deduction. However, you run a risk that you might have to prove to the IRS that you did, in fact, paid this interest, so keep good records. In order to minimize this IRS audit risk, be careful choosing the line on which you report interest. Choose "Other interest" instead of "Mortgage interest."

Part 2: Forms 1099-INT from investors to private lenders

This is the form that you used to receive from banks back when the banks paid interest on your savings. It tells you how much interest you must include in your taxable income. It also tells the IRS to expect taxes from you on this income. Naturally, the IRS computer will match your 1099-INTs against your tax return. If you reported less than what they think you should have - expect an automatic adjustment, a letter or even an audit.

Since in case of private money you as an investor act similar to a bank paying interest to the lender - should you send your private lender form 1099-INT? Yes, you should, but only IF you check the 2 boxes:

1. You run "a trade or business." If you're a flipper - then most likely you do. If you're a landlord - you still probably do, however this is debatable. We tell most of our landlords clients to consider themselves as running a trade or business, because it allows them to claim business overhead expenses, among other benefits.

2. The annual interest paid on this private loan was $600 or more for the prior year.

If you're a private lender, you must report the interest you collected on your private loans as taxable income whether or not you received a 1099-INT from your borrowers. This is no different from not receiving a 1099-NEC for some contract work: even without a form, you must report the money you received as income and pay taxes.

Final disclaimer: there's more to these rules than I mentioned, and there's room for interpretation in many situations. However, since filing these forms is a very minor hassle, my general advice is: when in doubt, do send these forms, just in case.