Investment Income: Definition, Example, and Tax Treatment

What Is Investment Income?

Investment income is money received in interest payments, dividends, capital gains realized with the sale of stock or other assets, and any profit made through another investment type. Investment income also includes interest earned on bank accounts, dividends received from stock owned by mutual fund holdings, and the profits on the sale of gold coins. Long-term investment income undergoes different—and often preferential—tax treatment, which varies by country and locality.

Understanding Investment Income

Investment income refers solely to the financial gains above the original cost of the investment. The form the income takes, such as interest or dividend payments, is irrelevant to it being considered investment income so long as the income stems from a previous installment.

People generally earn most of their net income each year through regular employment income. However, disciplined saving and investment in the financial markets can grow moderate savings into large investment portfolios, yielding an investor a sizeable annual income over time. This type of income can come from different investment vehicles, including savings accounts, certificates of deposit (CDs), and bonds.

Businesses often have income from investments. On the income statements of public companies, an item called investment income or losses is commonly listed. This is where the company reports the portion of its net income obtained through investments made with surplus cash instead of being earned in its usual line of business. For a business, this may include all of the above, as well as interest earned or lost on its bonds that have been issued, share buybacks, corporate spinoffs, and acquisitions.

Types of Investment Income

The interest accrued on a basic savings account is considered investment income. It is earned on top of the original investments—the deposits placed into the account—which can make the account a source of income.

Options, stocks, and bonds can also generate investment income. Whether through regular interest or dividend payments or by selling a security at a higher price than was paid. Any amount received above the original cost of the investment qualifies as investment income.

Real estate transactions can also be investment income. Some investors purchase real estate to generate investment income—either from the cash flows generated from rents or any capital gains realized when selling the property. Once the original property cost is repaid, the income qualifies as investment income provided rent payments received are not used to cover other property-related expenses.

Taxation of Investment Income

Most (but not all) investment income is subject to preferential tax treatment when the income is realized. The associated tax rate is based on how long an investment is held, its type, and an individual taxpayer's situation.

For example, retirement accounts such as a 401(k) or traditional individual retirement account (IRA)are subject to taxes once the funds are withdrawn. Certain tax-favorable investments, such as a Roth IRA, are not taxed on eligible gains associated with a qualified distribution. Meanwhile, long-term capital gains and qualified dividend income are subject to a maximum federal tax that is adjusted every year.

Investment income can also be used in conjunction with an individual's earnings to provide income tax credits. For example, one of the criteria used to evaluate individuals for the Earned Income Tax Credit (EITC) is earning from running a small business and not having investment income over a specified income threshold.

Example of Investment Income

Suppose an investor buys stock in company ABC for $50. Two weeks later, the investor sells them for $70, netting a profit of $20. This is a short-term investment, so the gain is taxed at the investor's regular earned income tax rate (federal tax law defines a short-term investment as one owned for less than a year).

Suppose the same individual invests $500,000 in real estate property. The investor sells the property for $1.5 million 10 years later. The investment is categorized as long-term investment income and taxed at the long-term capital gains tax. The tax percentage depends on the overall income of the taxpayer.

The Bottom Line

Any money you derive from your investments is considered investment income. This includes interest earned from savings accounts, dividends, capital gains you realize after selling an asset, and then sales of mutual funds to name just a few. If you have investment income, it's important to understand its tax treatment, which is different income you earn from an employer. Follow the tips listed above or catch up on Investopedia's Guide to Income Tax for more information. If you're still unsure, speak to a financial or tax expert.