A recent Wall Street Journal article has shed some light on the growing number of small business owners using peer-to-peer lending websites to help fund their businesses. With small-business owners being turned away by banks or not interested in with unattractive lending terms, a growing number of small business owners are turning to Internet sites that match borrowers with large pools of lenders when they need to borrow funds for their business. This has led to the increased popularity of internet sites that focus on peer-to-peer lending.
Peer-to-peer lending sites, such as Lending Club and Prosper have seen a large increase in the number of private loans being completed via their websites. The way the majority of peer-to-peer lending websites work is that the sites generally charge borrowers a fee for connecting them to a network of lenders. Lenders are paid back with interest, with the rate set on the basis of a site-assigned credit rating, minus the site’s fee. Most loans are for less than $10,000, but they can exceed $30,000.
A number of savvy investors have recognized that the IRS does not prohibit the use of retirement funds, such as IRA and 401K Plan assets, to be used for peer-to-peer lending. As long as the lender or borrow is not a disqualified person pursuant to the rules under Internal Revenue Code Section 4975, one can use their retirement funds, either through a Self Directed IRA or Solo 401K Plan, to engage in peer-to-peer lending.
With the establishment of a Self Directed IRA LLC or a Solo 401K Plan, a retirement investor would be able to access his or her retirement funds in order to engage in peer-to-peer lending transactions with friends or through websites such as Lending Club or Prosper. Since interest generated by a retirement account is tax free and not subject to the Unrelated Business Taxable Income rules under Internal Revenue Code Section 512, interest generated by the loan will be received tax-free by the retirement plan.
The use of a Self Directed IRA or Solo 401K Plan to engage in peer-to-peer lending transactions is a very attractive tax efficient structure since all interest will flow back to the Self Directed IRA or Solo 401K Plan tax-free. The way the peer-to-peer loan transaction would work is as follows: The lender of the loan would be the Self-Directed IRA LLC or Solo 401K Plan. The loan to the borrower, who must not be a disqualified person, would be made in the name of the Self Directed IRA LLC or Solo 401K Plan. The borrower would make interest and principal payments directly to the Self Directed IRA LLC or Solo 401K Plan. All interest received would be tax-free.