I used to be amazed at the number of doctors who did not know the difference between ‘realized income’ and ‘unrealized income’. Till I addressed about 400 Chartered Accountants. Then I stopped being shocked. I realized that what is intuitive for some people it is not so intuitive for everybody.

What is the difference between ‘Income’ that is realized and ‘increase in net worth’ which may remain on paper?

Let us put it this way Realized income is current income – on which you pay Income tax at regular rates IMMATERIAL of whether you need the income or not. By the way we are talking only of investment related income. Your professional income, business income, or salary income will ALWAYS be realized.

When we were doing CA one of the most important tax planning ideas was to convert a current income to a capital income – and pay lesser taxes. Exactly what I am advocating now. I was surprised that many CA were not using this simple tool.

Such examples are rent, dividends, bank interest, interest on bonds, interest on loans given, etc. and it is a percentage of the return. In fact the first two – rent and dividends are a small fraction of the asset. More is supposed to be got by appreciation.

Unrealized income is the income that ‘accrues’ – and is not realized. It is money that you “earn” like when your investments go up in value, but you don’t sell them to get the profit or the cash into your bank account, which would turn it into “realized” income. Like the appreciation of a mutual fund Growth option.

A home or clinic or place of work  is another perfect example of unrealized income.

You bought the home for Rs. 2,000,000 ( you’ve paid the mortgage off), and it is now worth Rs. 4,000,000. Your net worth has now gone up Rs. 2,000,000 but you haven’t realized the income, because you haven’t sold the home. Or you have bought shares worth Rs. 33 lakhs which is now worth Rs. 80L and you have not sold any share – you never felt the need for money.

What can we do?

Well we need our regular income to live, but we can put our assets in ‘accumulation’ mode – like ‘Growth’ option in mutual funds instead of dividend mode. ALWAYS. WELL almost always. Except when you need some income.

So let us say you have post tax income of Rs 7L – and your house expenses are about rs. 6L – you can invest Rs. 1L every year. This should be done in tax deferred or tax free income generating assets. For example Growth option of mutual funds or PPF where the interest is tax free anyway.