Tax Topics: What is Passive Income?

[Shafi Noss]

Hi everyone, in my last post I wrote about the tax benefits that non-real-estate professionals enjoy by investing in a syndication. There were some wonderful answers by Charles LeMaire and Roni Elias among others. It brought up a new topic of distinguishing between different types of income I'd be interested to hear people's thoughts on.

There are three types of income: Active, passive, and portfolio income.

Active Income comes from wages, salaries, and tips. Passive income comes from rent, LP profits, and royalties. Portfolio income comes from capital gains, interest, and dividends. I also hear mention of royalties from investment property as part of portfolio income. 

How does capital gains profit from LP participation fit into this framework? One the one hand it is income from LP participation in a business. On the other it is a capital gain.

What does an investors tax situation look like on capital gains profits from LP participation in a deal?

[Jaysen Medhurst]

@Shafi Noss, capital gains can be offset by depreciation. That's one of the reasons why a cost segregation study is so powerful. By pulling forward 15 years of depreciation (I'm making up that number) and applying it to the first 2-5 years, there is typically "left over" depreciation that can offset any gains at the time of sale, say year 5. Once you have the depreciation, you never lose it. It rolls over year after year to offset subsequent passive gains.

LPs "invest." They buy a security and are no more involved in the business than is someone who buys $50k of stock in Apple.