While losing money in a business may seem like a bad idea, many people are able to offset this loss with passive income from other sources. Passive income includes any type of year-round income that comes from an outside source which you were not actively involved in earning. This can include interest payments, dividends, and distributions from a partnership.
Why passive income can offset active losses: Active losses lower the total tax owed
Losses incurred through active income can be offset by generating passive income, but it is important to maintain a balance between the two avenues of earning. While it may seem like passive income should always outweigh active losses, generating too much passive income can lead to an audit, which could result in additional taxes.
The drawbacks of using passive income to offset active losses
Active losses are typically incurred by people who have side jobs or invest in things other than stocks, bonds, and mutual funds. The IRS has an Active Loss Limitation rule for those with passive income, which states that the total amount of passive income cannot exceed the total amount of active losses. Problems can arise if you are not diligent about offsetting your losses with your earnings. For example, if you have $10,000 of active losses and $20,000 of passive income, you will have to subtract $20,000 from your passive income to get the correct amount of income for a tax return.
Passive income may be used to offset active losses but should not be depended on.
Passive income is a term that can be used to describe any money earned from sources other than employment. By earning money passively, people are able to focus on generating more income or developing their skills instead of actively seeking out work. For many people, passive income provides an opportunity for a more sustainable and reliable way of making money than the traditional job hunt. When both active and passive incomes are combined, it can offset losses from other investments that don’t do as well as expected.