Passive Income
Passive income is earnings from investments requiring little ongoing effort, such as DST distributions or rental income, and is taxed under special IRS rules.
Definition
Passive income is money earned from an enterprise in which you do not materially participate, most commonly rental real estate and limited-partner interests. For 1031 and DST investors, it is the core appeal: replacing the work of being a landlord with distributions that arrive without active involvement.
The IRS has specific passive activity rules. Rental activities are generally passive by default, and passive losses can usually only offset passive income, not wages or portfolio income. This matters because depreciation from real estate can shelter passive distributions, sometimes making a portion of DST income tax-deferred during the hold.
For example, a retiree who sells a management-intensive apartment building and exchanges into DSTs trades active rental income for passive distributions, say $4,000 a month, while a property manager handles everything. Understanding the passive classification helps investors plan how that income, and any losses, will be taxed.
Key points
- Income from investments you do not materially participate in
- Rental real estate is generally passive by default
- Passive losses typically offset only passive income
- Depreciation can shelter part of DST distributions
Related terms
Jerry Baker founded Baker 1031 Investments to help exchange investors move from active property ownership into passive, institutional-quality real estate through DST, 721 exchange, mineral royalty, and Opportunity Zone strategies. He holds the FINRA Series 22 and Series 63 registrations and the Securities Industry Essentials (SIE) qualification. Read full bio →
Reviewed by the Aurora Securities, Inc. compliance team — Aurora Securities, Inc., member FINRA/SIPC. Last reviewed July 2026. Securities are offered through Aurora Securities, Inc.; Baker 1031 Investments, LLC is independent of Aurora Securities, Inc.
This glossary entry is educational and is not investment, tax, or legal advice, or an offer to sell or a solicitation to buy any security. Definitions are general and may not reflect your specific circumstances — consult your own CPA and attorney. Past performance does not guarantee future results.