What sort of tax treatment does a charitable micro-lending loan incur?
So, a friend of mine has encouraged me to look at Kiva (http://kiva.org) which does microlending and has a big fat legal agreement that says (among other things) 1.3 Tax Deductibility. You understand that Kiva is a non-profit public benefit corporation. Kiva has received exemption with the Internal Revenue Service as an organization that qualifies as a public charity under Section 501(c)(3) of the Internal Revenue Code of 1986, as amended from time to time. You acknowledge, however, that because you are making a Loan and not donating any money, you are not eligible to receive a tax deduction as might otherwise be available in connection with a charitable contribution to a tax-exempt public charity. You also understand that you are solely responsible for determining the proper tax treatment for any Loan you make through the Website and the Program. Kiva has not and will not provide any tax or legal advice to you in connection with any Loan you might make. This Agreement does not attempt to define the tax implications of participating in the Program. If you participate in the Program, you should consult with your own accountants, tax advisors and legal advisors. So there are two kinds of tax treatment I'm curious about: Is there any potential to have the IRS accuse you of incurring a tax liability in relation to this lending? What sort of capital losses does the IRS allow you to deduct in the event of a charitable loan gone sour? Has there been any guidance issued on this topic? EDIT EDIT EDIT EDIT I used the term charitable loan specifically because you cannot earn a profit from a Kiva loan. Loans made via the Website are philanthropic in nature with no offered rate of return and, as such, are not intended as, and cannot be considered as, an investment in a financial instrument or security. I'm aware that you can't deduct the principal of the loan as a charitable donation. I'm certainly not going to try and deduct the opportunity cost of making the loan. But it is charity, you can't make a profit off it, and you will lose out on interest on the money you could have made (and may incur principal losses as well). I am specifically interested in whether there's any background information on tax treatment of "lending money you can lose but not make interest off of", or if there's some other quirk of the tax structure which could make you liable for taxes even if you don't get paid interest.
Lending is not a charitable contribution. Its an investment.
If the loan becomes a bad debt – you’ll have to show that it had become a bad debt. For example – bankruptcy declaration. You’ll have to show an arm’s length transaction, for example – real intention to repay (evidenced by payments of principal and interest made). Otherwise if you have an intention for the loan to never be repaid, it is in fact a gift, which is not only not deductible – its taxable.
Bottom line – be careful and talk to a EA/CPA to get a proper advice with regards to a specific transaction.
Edit to answer your revised question: you’re not going to pay taxes if you’re not going to have gains. However, if you lose the principal, in addition to the said above you would incur the loss as a personal bad debt, and not business. This is because it is not investment. The difference is in tax treatment: personal bad debt is a short-term capital loss (limited deduction), business is an ordinary loss.
When lending through Kiva you are not making a “charitable contribution” it’s a loan so you cannot deduct the amount you loaned out.
If you do lose money from your loan you can write off your entire loss same as you would with any other investment. However you should be careful because in the event of a tax audit you need to have the proper documentation in order to prove that loss (I don’t know what Kiva provides).
So to answer your question, no you would not be liable for any taxes from a Kiva loan.
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