Passive Income Generators and Passive Activity Losses
PIGs n' PALs - Structuring investments to generate tax advantaged income
Passive Income Generators
What is Passive Income?
Passive income is earnings derived from a rental property, limited partnership, or other enterprise in which a person is not actively involved or has "material participation".
The Internal Revenue Service refers to it as "unearned income" because of the minimal effort to obtain as opposed to active income, which is income received from a job or business venture that requires active participation such as working for an employer or as a contractor.
Passive Income Treatment
The IRS usually taxes passive income at the same rate as salary received from a job. However, certain sources of income may be taxed at a different rate, and it is sometimes possible to use deductions to reduce the liability.
When you record a loss on a passive activity, only passive-activity profits can have their deductions offset, as opposed to the income as a whole.
Offsetting Passive Income Generators (PIGs)
with Passive Activity Losses (PALs)
How to Get Passive Income
Partnerships or limited liability companies allow a passive investor to receive shares of income as well pass through deductions such as depreciation, depletion, and other expenses.
Acquiring assets through passive ownership structures provides the potential for investment in real estate, rental equipment and other assets that may offer income that is offset by deductions from the assets themselves or opportunities to generate passive income which may be offset by outside passive losses.
PIGs n' PALs
Offsetting Income and Losses
The ultimate objective is to generate passive income and have it equally offset by passive losses. Many passive income generators such as real estate utilize cost segregation, accelerated expenses, deprecaition and other pass through deductions that offset significantly the income they generate themselves. Some investments generate excess income which needs to be offset by outside passive activity losses.
Passive Activity Losses
One investment that generates significant passive activity losses is solar development. In addition to tax credits, a typical solar development partnership will provide a sizeable amount of depreciation allowance that can offset passive income. Solar tax credits can offset dollar per dollar the tax liabilities owed on passive income.