How to Keep Track of Passive Income

Track passive income using categories based on your specific income sources.

Passive income is one of three income categories in accounting --- active income and portfolio income are the other two categories.The IRS defines passive income as income from "trade or business activities in which you do not materially participate." The IRS concept of passive income is best understood by describing what doesn't constitute passive income. This generally includes such broad categories as earned income from wages and capital gain income.

Instructions

1. Exclude all incomes generated from activities in which you materially participate. The main characteristic of passive income is that the party receiving it doesn't materially participate in the activities that generate the income. As a result, wages from a job where you work is clearly excluded from the passive income category. Passive income might include income derived from a limited partnership in which the person operates like an investor and doesn't materially participate in the business operations.

2. Track rents as passive income. Subject to certain exceptions, income derived from rents, whether the person materially participates or not, is considered passive income for IRS reporting purposes. This might include income that you generate from leasing tangible real property to an individual or company. This might also include rents from leasing tangible personal property, such as automobiles. In the later case, this income activity likely has to occur outside of a business operation; otherwise, it would likely be categorized as active income.

3. Take note of express IRS exclusions from the passive income category when categorizing income. The IRS doesn't consider capital gains on stocks and bonds passive income. Additionally, interest, except self-charged interest, is also excluded from the passive income category. The IRS also doesn't consider royalties from intellectual property, such as patents and copyrights, as passive income.

4. Beware of ambiguities in the accounting language. As an example, for general accounting and investment purposes, dividends and interest might be considered "passive income streams" because they generate income with minimal work requirements. If you're categorizing passive income for tax purposes, check with a tax professional or with the IRS if you're having difficulty categorizing active, passive and portfolio income for tax reporting purposes.

References

• Internal Revenue Service; Passive Activity Loss ATG --- Passive Income; December 2004
• Internal Revenue Service; Passive Activity Loss ATG --- Passive Income Decision Tree; December 2004
• Walden University; Business Investment Ideas; August 2011
• UCLA Anderson School of Management: Passive Activity Losses

Resources

• Internal Revenue Service; Publication 925 --- Passive Activity and At-Risk Rules; 2010