Income has a very broad definition, including increases in wealth from any source. The concept of realized income is important for tax purposes because it separates income that isn't subject to current taxation from income that potentially could be subject to tax. Let's take a closer look at what realized income is, and how to calculate it.

What realized income is
Realized income includes income that you've actually earned and received. Wages and salary income that you earn is included in realized income, as are interest and dividend payments from your investment portfolio. For those who invest in real estate, rental income is also realized when received, and small businesses owners can include their business income, as well.

Where there's an important distinction between economic income and realized income is with appreciating assets. If a stock you own rises in value, then you have an economic gain, which is sometimes called a paper gain. However, that doesn't become realized income until you actually sell the stock. Because of this distinction, long-term investing is a powerful way to defer taxation, as you control when you sell, and therefore, when your gains will be subject to tax.

Calculating realized income is as simple as adding all these sources of income together. However, once you do, there's another step you'll need to consider if you want to figure out the income on which you'll be taxed.

Realized income vs. recognized income
In trying to determine taxable income, realized income is only an intermediate step. The tax laws allow taxpayers to avoid recognizing certain types of income for tax purposes, even once it's realized.

One example is with the sale of a home. Any profit from that sale is realized income. However, current tax law provides single taxpayers with an exemption of up to $250,000 from capital gains taxes on the sale of a qualifying personal residence. As a result, the IRS doesn't treat capital gains up to that amount as recognized income, and therefore, you're not taxed on it.

Knowing your realized income is important, but it's not always the final answer you want. Only by considering tax exemptions on certain types of realized income will you get the result that you're really looking to find.

The $15,978 Social Security bonus most retirees completely overlook
If you're like most Americans, you're a few years (or more) behind on your retirement savings. But a handful of little-known "Social Security secrets" could help ensure a boost in your retirement income. In fact, one MarketWatch reporter argues that if more Americans knew about this, the government would have to shell out an extra $10 billion annually. For example: one easy, 17-minute trick could pay you as much as $15,978 more... each year! Once you learn how to take advantage of all these loopholes, we think you could retire confidently with the peace of mind we're all after. Simply click here to discover how you can take advantage of these strategies.

This article is part of The Motley Fool's Knowledge Center, which was created based on the collected wisdom of a fantastic community of investors based in the Foolsaurus. Pop on over there to learn more about our Wiki and how you can be involved in helping the world invest, better! If you see any issues with this page, please email us at Thanks -- and Fool on!