What Is Investment Income?
Generally, individuals earn most of their total net income each year through regular employment income. However, disciplined saving and investment in the financial markets can grow moderate savings into large investment portfolios, yielding an investor a large annual investment income over time.
Interest earned on bank accounts, dividends received from stock owned by mutual fund holdings, or sales of gold coins held in a safety deposit box are all considered investment income. Often, income made on investments undergoes different—and sometimes preferential—tax treatment, which varies by country and locality.
- Investment income is income that is earned from investments, such as real estate and the stock market.
- Investment income is taxed at a different rate once it is withdrawn as compared to regular income.
Businesses also often have income from investments. On the income statements of publicly traded companies, an item called investment "income or losses" is commonly listed. This is where the company reports the portion of the net income obtained through investments made with surplus cash, as opposed to being earned with the company's usual line of business. For a business, this may include all of the above, as well as interest earned or lost on its own bonds that have been issued, share buybacks, corporate spinoffs, and acquisitions.
Understanding Investment Income
Investment income refers solely to the financial gains above the original cost of the investment. The form the income takes, such as interest or dividend payments, is irrelevant to it being considered investment income so long as the income is generated from a previous investment. Additionally, investment income can be received as a lump sum or regular interest payments paid out over time.
Investment Income Made Simple
In the simplest form, the interest accrued on a basic savings account is considered income. The interest is generated as an amount above and beyond the original investments, which are the deposits placed into the account, making it a source of income.
Options, stocks, and bonds can also generate investment income. Whether this is through regular interest or dividend payments or selling a security at a higher rate than it was purchased, the funds above the original cost of the investment qualify as investment income.
Investment Income and Taxes
While it is not always the case, the majority of investment income is subject to a preferred level of taxation once the funds are withdrawn. The associated tax rate is based on the form of investment producing the income and other aspects of an individual taxpayer’s situation.
Many retirement accounts, such as a 401(k) or traditional IRA, are subject to taxation once the funds are withdrawn. Certain tax-favorable investments, such as a Roth IRA, are not taxed on eligible gains associated with a qualified distribution.
For example, as of late 2020, the top marginal tax rate on income is 37% (for amounts over $518,400 a year). Meanwhile, long-term capital gains and qualified dividend income is subject only to a maximum 20% tax, even if that amount exceeds a half-million dollars in a given year.
Investment income can also be used in conjunction with an individual's earnings in order to provide income tax credits. For example, one of the criteria used to evaluate individuals for the Earned Income Tax Credit (EITC) is earning from running a small business and not having investment income over $3,500.
Real estate transactions can also be considered investment income, and some investors choose to purchase real estate specifically as a way to generate investment income—either from the cash flows generated from rents or from any capital gains realized when selling the property.
Once the original cost of the property is repaid by the investor, and rent payments received are not used for the purpose of covering other property-related expenses, the income qualifies as investment income.
Examples of Investment Income
Suppose an individual buys stocks of company ABC for $50. Two weeks later, they sell them for $70, netting a profit of $20 in the process. Then the income they earned from their investment in company ABC is considered investment income and taxed accordingly.
Suppose the same individual invests $500,000 in real estate property. They sell the property for $1.5 million 10 years later. Then their investment is categorized as investment income and taxed on the basis of long-term capital gains tax.