Investment income is earning and profits from a wide range of assets, most commonly as capital gains, dividends and interest.
Most people earn the majority of their income through regular employment, working for salaries or wages. Income from investments is different.
Investment income comes from the financial gains made on assets, typically stocks, bonds or real estate. It can be received either in a lump sum or in regular installments, most commonly as capital gains, dividends or interest.
Generally, investment income is taxable, but rates vary depending on the type.
There are many types of investment income. Here are three common types:
1. Capital gains are derived from a rise in the value of an asset relative to its purchase price –though it’s not realized until the asset is sold. For example, a home you buy today may gain value over the years ahead. But even as its value goes up, you won’t receive capital gains until you sell the property.
Taxes on your capital gains will probably be due in the period you made the sale.
2. Dividends are the payments made by a company to its shareholders. If you’ve invested in dividend-paying stocks either directly or in a mutual fund, you’ll earn dividends on a yearly or quarterly basis, following the stock’s agreement.
Dividends are taxable. Ordinary dividends are subject to income tax rate, while qualified dividends are taxed at capital gains rate, which is usually lower than the regular tax rate.
3. Interest is typically paid on savings accounts, money market accounts, certificates of deposit and bonds. Tax rates vary depending on the asset.
Here’s an example of how investment income typically works. Let’s say today you buy 100 shares in a company purchased at $20 each. Your total investment would be $2,000. A month from now, you decide to sell your shares when the value of the shares increases to $30 each. The current value of the stock would be $3,000.
If you decide to sell it, your profit of $1,000 would be considered investment income. Following the federal tax laws for short term investments (less than a year), your profit would be taxed at your income tax rate.
Now let’s look at a real estate example, another type of asset that produces investment income. Let’s say you purchase a home for $200,000, and after 10 years, you sell the house for $1,000,000. Your profit will be taxed at the long term capital gains tax slab.
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When thinking about investment income, it’s important to have all your other finances in order, with debts, savings and goals clearly in mind.
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With a postgraduate degree in commerce from The University of Sydney, Pranay has his finger on the pulse of the finance industry. Breaking down complex financial concepts is his forte.