If your are deciding whether to invest in real estate actively or passively, you must first consider several factors. Active investors, for example, tend to be more hands-on and favor flips or wholesales. Passive investors, on the other hand, tend to gravitate towards buy-and-hold assets. It is also worth noting one additional difference investors need to account for: the passive income tax rate.
As you will soon discover, passive income is technically taxed a lot like active income. While the two sources of income are relatively similar, passive income awards qualifying earners with several benefits that can be realized at the time taxes are due. Keep reading to discover if you’re eligible.
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Passive income is typically used in the real estate community to describe the profits generated as the result of little or no effort on behalf of the person receiving them. In other words, passive income is exactly what it sounds like: a stream of income that isn’t contingent on trading time for money. Subsequently, there are two kinds of passive real estate activities:
As the counterpart to passive income, active income represents profits earned from performing a service. Active income is, therefore, the direct result of trading time for money. In the world of real estate investing, generating active income requires investors to continually buy and sell properties; their success or failure is entirely contingent on the effort they put into a deal. That said, active income isn’t relegated to real estate investors. According to the IRS, active income may also be derived from the following activities:
Material and non-material income are indicators used by the IRS to determine whether or not an individual made his or her income actively or passively. More specifically, an individual’s income will be classified as either material or non-material based on the amount of time they spent working to earn it. “A trade or business activity isn’t a passive activity if you materially participated in the activity,” according to the IRS.
The government separates workers into these categories for one very specific reason: to prevent people from receiving tax breaks they don’t deserve.
According to the IRS, you are a material participant if you satisfy any of the following criteria:
If you fail to meet any of the criteria listed above, you are likely a recipient of non-material income. As such, the income you receive may be of a passive nature, and therefore, able to benefit from certain tax losses.
For a better idea of the benefits one could expect to receive from passive income, please refer to the following section.
For most, the greatest passive income benefit is in the name: passive income. Few benefits can compete with the idea of making money passively. However, the passive nature of this investment strategy is far from the only reason investors covet it. As it turns out, some of the greatest benefits for investors have to do with the resulting tax breaks. Let’s take a look at some of the best tax benefits for passive income investors:
Real estate investing has become synonymous with some of today’s greatest tax benefits. In fact, there’s an entire contingent of investors who invest primarily to deduct from their taxable income each and every year.
While there isn’t exactly a standard passive income tax rate per se, there are additional benefits buy-and-hold investors can claim that other investors can’t. Therefore, you may want to consider investing in a few rental properties of your own if you want to maximize next year’s tax return.