Passive Income: I do not want to go back to working 50 plus hours a week, ever.

Types of Passive Income:

  • REAL ESTATE – The most popularly written about passive income stream. From an accountant’s perspective (my perspective), one who has prepared 1,000’s of tax returns, this passive income stream requires the most effort. This works well for highly motivated, organized individuals. The optimal situation is having a management company that handles everything tenant related including the collection of rent, repairs, finding prospective tenants, evictions, late fees, preparation of monthly and yearly statements.
    • Some individuals do not mind handling all tenant-related items themselves but for most this is a chore and if the record-keeping is unorganized, it will delay the preparation of the tax return (see Things Your CPA Will Not Tell You).
    • Many of my real estate clients rely on rental income as their sole source of income. Their tax returns usually reflect a loss which carryforwards to the next year. (Passive activity income losses can only be taken if there is another source of passive activity income, for example Schedule K-1 profits to counter the loss). Subject to Passive Activity Rules.
    • I find that commercial real estate is less of a hassle but requires a higher initial investment than residential real estate.
    • AiRbnb – short-term rentals. I wish people that offer these short-term rentals would align their mind-set with that of a hotel owner – organization is key to tracking income and expenses. Passive Activity Rules may not apply.
    • Tax treatment – Subject to maximum federal capital gains tax rate from any portion of the gain (sale) on commercial real estate. For 2018 tax reporting, at a top capital gains rate of 25% and might be subject to an additional 3.8% tax for net investment income.
    • When you are ready to sell your real property see post 1031 Exchanges (Like-Kind) to learn the steps to defer capital gains taxes.
  • INTEREST INCOME– this includes high-interest savings accounts, money market savings, certificate accounts (CDs). The optimal situation is compounding interest. When you deposit money in a savings account or a similar account, you will usually receive interest based on the amount that you deposited. Compound interest is interest that you earn on interest. https://www.bankrate.com › banking › what-is-compound.
    • While a $100,000 deposit that receives 5% simple annual interest would earn $50,000 in total interest over 10 years, the annual compound interest of 5% on $10,000 would amount to $62,889.46 over the same period. If the compounding period were instead paid monthly over the same 10-year period at 5% compound interest, the total interest would instead grow to $64,700.95. https://www.investor.gov/financial-tools-calculators/calculators/compound-interest-calculator
    • Tax treatment – Taxed as ordinary income depending on your tax bracket.
    • Credit unions – I would recommend opening an account at a credit union. Credit unions offer various interest accounts, usually pay higher interest rates than ordinary banks, and offer low fees.
  • ROYALTIES -payments received for original works such as books, films, articles, poems, trademarks, trade names, service marks or copyright. I recently prepared a client’s tax return who receives $20,000 annually from an internet service provider for the use of their land for an internet tower.
  • STOCK DIVIDENDS – monthly, quarterly.
    • Notice that I limited investing in the stock market to stock dividends. To be a successful stock investor requires a lot of work. My clients that are successful investors dedicate many hours every day. This is their full-time job (i.e., day traders) and not a passive income stream. A successful investor needs to invest a lot of time in researching stocks (e.g., Options, ETFs, Futures, Swaps) before purchasing. To achieve success, an investor should begin by researching a company’s financial statements, the competition, reading the latest industry news, company news, CEO news, innovations, trends, . (Filings & Forms https://www.sec.gov/edgar.shtml).

MY INVESTMENT STRATEGY

  1. I began by investing in stock dividends by emulating Warren Buffett. First, I reviewed his holdings. https://money.usnews.com/investing/stock-market-news/articles/the-complete-berkshire-hathaway-portfolio?src=usn_invested_nl&utm_source=Sailthru&utm_medium=email&utm_campaign=US%20News%20Invested-Tue%20May%2025%2006:48:00%20EDT%202021&utm_term=US%20News%20Invested
  2. Next, I reviewed a list of Dividend Aristocrats. “A Dividend Aristocrat is a company in the S&P 500 that has paid and increased its base dividend every year for at least 25 consecutive years.” https://www.fool.com/investing/stock-market/types-of-stocks/dividend-stocks/dividend-aristocrats/
  3. What is great about today’s market is there are apps that allow you to invest in stocks partially (CashApp, Stash). Whereas in the past, a substantial amount of money and a financial advisor was required to invest. So, this is where I started. I made an excel spreadsheet, checked the dividend yields (average 3%), checked the companies’ beta (i.e., risk assessment), industry sector, reviewed financial statements, and chose accordingly.
  4. I also have a high-interest savings account, Money-market checking account (credit union), and various CDs (certificate of deposit) 3-month, 6-month, 12-month, a HSA, and a 401(K). I am working on royalty income, blog revenue, maybe a municipal bond also. As you can see, I am very conservative when it comes to investing. I believe in a low-risk strategy. I review, research, and adjust periodically.

  • BONDS– “A bond is a long-term contract under which a borrower agrees to make payments of interest and principal, on specific dates, to the holders of the bond. Investors have many choices when investing in bonds, but bonds are classified into four main types: Treasury, corporate, municipal, and foreign. Each type differs with respect to expected return and degree of risk.”(1)
    • Treasury Bonds -sometimes referred to as government bonds, are issued by the U.S. federal government.(1) It is reasonable to assume that the federal government will make good on its promised payments, so these bonds have almost no default risk. However, Treasury bond prices decline when interest rates rise, so they are not free of all risks.(1)
    • The U.S. Treasury issues three types of securities: “bills,” “notes,” and “bonds.” A bond makes an equal payment every 6 months until it matures, at which time it makes an additional lump-sum payment. If the maturity at the time of issue is less than 10 years, the security is called a note rather than a bond. A T-bill has a maturity of 52 weeks or less at the time of issue, and it makes no payments at all until it matures. Thus, T-bills are sold initially at a discount to their face, or maturity, value.(1)
    • Tax treatment– Interest income from Treasury bills, notes, and bonds is subject to federal income tax but is exempt from all state and local income taxes https://www.irs.gov/pub/irs-pdf/p550.pdf
    • Corporate Bonds – issued by corporations. Unlike Treasury bonds, corporate bonds are exposed to default risk-if the issuing company gets into trouble, it may be unable to make the promised interest and principal payments. Different corporate bonds have different levels of default risk, depending on the issuing company’s characteristics and the terms of the specific bond. Default risk is often referred to as “credit risk,” and the larger the credit risk, the higher the interest rate the issuer must pay.(1)
    • Municipal Bonds – or “munis,” are issued by state and local governments. Like corporate bonds, munis have default risk. However, munis offer one major advantage: The interest earned on most municipal bonds is exempt from federal taxes and from state taxes if the holder is a resident of the issuing state. Consequently, municipal bonds carry interest rates that are considerably lower than those on corporate bonds with the same default risk.(1)
    • ” muni bonds generally require a $5,000 minimum investment, while corporate bonds start at $1,000″ https://www.fool.com/investing/how-to-invest/bonds/municipal-bonds/
    • Foreign Bonds – are issued by foreign governments or foreign corporations. Foreign corporate bonds are, of course, exposed to default risk, and so are some foreign government bonds. An additional risk exists if the bonds are denominated in a currency other than that of the investor’s home currency. For example, if a U.S. investor purchases a corporate bond denominated in Japanese yen and if the yen subsequently falls relative to the dollar, then the investor will lose money even if the company does not default on its bond. (Cont’d)

Published by Williams Accounting LLC

Williams Accounting LLC is a Las Vegas-based accounting, tax, and financial consulting firm that works with clients to achieve the best solutions for their business.

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