Unearned income is a type of personal income generated from sources unrelated to employment. The term was first coined by Henry George, and it also includes income received by virtue of investments, inheritance and even pensions.
What Is Unearned Income?
Unearned income is a type of income that is not acquired through direct work such as employment or business activities. Because of these differences, tax rates applied on earned incomes are usually different from unearned incomes. According to the Internal Revenue Service (IRS), earned income includes wages, salaries, tips and self-employment income.
What Is the Difference Between Earned Income and Unearned Income?
Earned income is the money you make in exchange for the work you do. On the other hand, unearned income is the money you make without having to perform any professional service. This income type functions differently than earned income because payroll taxes are not paid.
Other forms of taxes charged on Social Security and Medicare are not charged. But, unearned income from various sources will count toward the adjusted gross income on your state and federal tax returns according to line 37 of form 1040.
What Is Considered Unearned Income in Real Estate?
There are three major types of unearned income in real estate, namely:
- Rent – This is the type of income received on the basis of owning real estate assets.
- Interest – This is the type of income received by the virtue of ownership of financial assets.
- Profit – This is the type of income received on the basis of ownership of capital.
Other sources of unearned income include alimony, gifts, lottery winnings, welfare benefits, veteran affairs (VA) benefits, retirement accounts, inheritances and many more.
Benefits of Unearned Income
Unearned income has several benefits. Some of them include:
- Unearned income serves as a savings option before retirement. This is because, in most cases, taxes are deferred for most sources of unearned income.
- Additionally, unearned income can help you increase your working capital. Additionally, you can diversify your holdings from unearned income to even out the effect of taxes on unearned income sources.
Be Passive, But Pay Attention
When it comes to filing taxes, the distinction between earned income and unearned income must be thoroughly understood. While the distinction might seem like a minor one, it is important that you understand both so you do not end up with tax issues on your hands. Learn how to calculate your net operating income (NOI) and earnings before interest and taxes (EBIT) to get a clearer picture of your tax situation.