Passive Income Taxation
See how rents, dividends, interest, and royalties are each taxed, and how to keep the rate low.
TL;DR
- Tax each stream by its type:
qualifiedDividendsand gains beat interest. - Offset rental income with expenses and
depreciationto lower the tax. - Watch the 3.8%
NIITonce your income clears the threshold.
Know Your Income Type
Qualified DividendsDividends that meet the holding rule get gains rates.
0%, 15%, or 20%Ordinary DividendsDividends that miss the rule are taxed as income.
10%-37%InterestBank and bond interest is taxed at ordinary rates.
Ordinary; munis are federal-freeRents and RoyaltiesTaxed as ordinary income after expenses.
Ordinary, net of deductionsRental Income Rules
Deduct ExpensesInterest, repairs, insurance, and fees offset the rent.
Rent - expenses = taxableDepreciationWrite off the building over 27.5 years each year.
Building value / 27.5The $25,000 AllowanceModest earners can deduct rental losses against income.
Under $100k MAGI, phases out by $150kRecapture at SalePast depreciation is taxed back when you sell.
Up to 25% on recapturePassive Loss Rules
Passive Offsets PassiveA passive loss usually shelters only passive income.
Rental loss vs rental incomeSuspended LossesLosses you cannot use this year carry forward.
Banked for a future yearFreed at SaleSelling the activity releases its stored-up losses.
Sell = suspended losses unlockMaterial ParticipationRunning a business actively makes its income non-passive.
Active income dodges passive rulesKeep the Rate Low
Meet the Dividend RuleHold long enough to earn the qualified rate.
60+ days around ex-dividendHold Gains LongA year-plus turns gains into long-term rates.
0/15/20% vs ordinaryUse Municipal BondsTheir interest skips federal tax entirely.
Federal-tax-free interestMind the NIITA 3.8% surtax hits investment income of high earners.
Over $200k single / $250k jointTips
- Hold dividend stocks through the
holdingPeriod, more than 60 days around the ex-dividend date, so they are taxed as qualified, not ordinary. - Track suspended
passiveLosseseach year; they free up in full when you sell the activity that created them.
Warnings
- Selling a rental triggers
depreciationRecapture, taxed up to 25%, so the depreciation you claimed comes partly back at sale. - Passive losses usually offset only passive income, so a rental loss may not cut your
wageIncomeunless you qualify for the allowance.
In Practice
See what meeting the holding period saves on the same dividend payout.
You are single with $80,000 of income and receive $5,000 in dividends, putting you in the 22% ordinary bracket and the 15% long-term bracket.
- If qualified (held 60+ days): $5,000 x 15% = $750.
- If non-qualified: $5,000 x 22% = $1,100.
- The holding period is the only difference.
- Savings: $1,100 - $750 = $350.
Meeting the holding period drops the tax from $1,100 to $750.
Hold dividend stocks past the 60-day window for the lower rate.
FAQ
For tax purposes, passive income comes from rental real estate and businesses you do not actively run. Portfolio income, dividends, interest, and capital gains, is technically separate but planned around the same way. The label matters because passive losses can generally only offset passive income, not your salary.
Qualified dividends get the long-term capital gains rates of 0%, 15%, or 20%, while ordinary (non-qualified) dividends are taxed as regular income up to 37%. To qualify, you must hold the stock more than 60 days during the 121-day window around the ex-dividend date. Miss it and the higher rate applies.
Sometimes. If your income is under $100,000, you can deduct up to $25,000 of rental losses against other income, and that allowance phases out by $150,000. Above that, passive loss rules limit you to offsetting other passive income. The suspended losses are not lost; they free up when you sell the property.
While you own a rental, depreciation deductions lower your taxable income each year. When you sell, the IRS 'recaptures' that benefit: the portion of gain tied to depreciation is taxed at up to 25%, higher than the normal long-term rate. It is a reason your tax bill at sale can be larger than expected.