Using HELOC for a hard money loan - tax implications?

[Rumen Mladenov]

Let's say someone takes money out of a HELOC at 8% and lends it out as a hard money loan at 12%. After the loan is paid off, a 1099 is sent to the hard money borrower and the IRS showing the interest received. How can this be addressed at tax time so that only the actual income is taxed (12%-8%), not the whole 12%?

[Nicholas Aiola]

@Rumen Mladenov If the HML is in the business of lending, income will be taxed as ordinary income subject to SE tax and the HELOC interest paid would be deductible as a business expense.

If not, the income to the HML will be interest income (portfolio income) and the HELOC interest paid would be reported on Schedule A as investment interest. In this scenario, if the HML does not itemize, there will be no benefit received from the HELOC interest paid and the HML will be taxed on the full amount of interest income received.