The BK defaults (as opposed to the delinquency defaults that are sold to the JDB) are treated as non-business bad debts, which are counted as short-term capital losses, regardless of how long held. Oddly enough, that means that for most large lenders, it is much better for a borrower to go BK than for the loan to be sold off at the low end of the JDB range -- a lender in the 28% bracket (MFJ w/ AGI >$128,500), for example, reaps an extra 13% vs. the 15% capital gains rate -- considerably better than the low single digits the JDB pays for many loans. And the benefit grows with the lender's income -- MFJ w/ AGI >$195,850 is in the 33% bracket (an extra 18%), and for the extremely wealthy (MFJ w/ AGI >$349,700), the tax rate is 35% (a 20% premium).
This raises the question of whether Prosper could legitimately offer lenders some kind of "all or nothing" option which, if chosen by the lender at the time of bid, would include a clause in that lender's prommissory notes that immediately upon the loan reaching 4 months late, the lender's share of the loan becomes worthless, thereby allowing the lender to treat the loan as non-business bad debt. I imagine there would have to be a non-tax justification for such a provision, but perhaps the avoidance of carrying very long-term late loans would suffice, or perhaps some other justification could be found.