Understanding Portfolio Income and Tax Implications

Portfolio income is any money earned from investments through capital gains, dividend payments, interest payments or royalties. It is important to remember that portfolio income does not count as passive income during tax season. Passive income is subject to a wholly different set of tax laws, and losses in passive income may be written off. Portfolio income is not considered passive since it does involve some work on behalf of the investor. As a result, gains and losses must be reported and are subject to income tax.

Capital Gains Income

When you sell an asset for profit, you experience capital gains. This can be through the sale of socks, funds, commodities or even a property. Capital gains tax is fairly high, but it can be reduced through exchanges in the gains. Essentially, you have the option of deferring taxes on capital gains by placing the gains immediately toward the purchase of another asset, meaning you will not net any profit in the given year. A good example of this application is the 1030 exchange as it applies to real estate. The profits you gain from selling a property can be immediately applied to the purchase of another property. When you sell that property, you will pay taxes on the net overall gain, but taxes will be deferred until you actually net the profit.

Dividends and Interest Income

Dividends and interest can come hand-in-hand because they are the most common forms of payments received as a result of purchasing a security. Dividends are paid on stock based on the amount of earnings a company produces in a given year. Interest is paid on bonds based on the rate disclosed at the initial payment. Remember: interest paid on Treasury bonds is exempt from federal and state tax. Interest on municipal bonds in your state may also be exempt from local taxes. If you hold your securities in a retirement account, you dividend and interest payments are also deferred. You will not have to pay taxes on these sums until you withdraw from the account. This is useful because, if your income in the retirement account goes up and down temporarily, you will not be taxed for these swings.

Royalty Income

Royalties are any payments earned as a result of owning a property. For the definition of royalty income, the property under consideration includes certain types of land, copyrights held on any work and ownership of franchises. Remember: if you own an income property that generates rent, this qualifies as passive income. Passive income has a number of tax advantages, so you will want to declare it under that section instead of as royalty income. If you are earning a sizable amount of income off your portfolio investments, it is wise to consult with an accountant prior to filing your taxes. There are a number of completely legal and acceptable accounting strategies that can minimize your tax burden in years when you could use the extra money. Only you can decide when to seek these advantages, but an accountant can provide you with the necessary strategies.