What Is Passive Income?
Passive income is the cash flow generated by an individual with minimum or no effort at regular intervals. It gives them additional financial security while requiring some amount of hard work initially, such as maintaining rental properties, making investments, upgrading products, etc.
An individual can earn passively from any source besides working as a full-time employee, an employer, or a contractor. According to the U.S. Internal Revenue Service (IRS), a person can derive passive revenue from two sources, i.e., rental properties and business or trade activities. But that individual must not participate materially in these activities, except for making the investment or charging interests. Passive earnings are subject to taxation that is different from active income.
Table of contents
- What Is Passive Income?
- How Does Passive Income Work?
- Ideas Of Passive Income
- #1 -Space Rentals
- #2 – Royalties
- #3 – Asset Leasing
- #4 – Trade Or Business Activities
- #5 – Starting Franchises
- #6 – Infopreneurship
- #7 – Fixed Deposits In Banks
- #8 – Invest In Financial Products
- #9 – Network Marketing
- #10 – Self-Service Businesses
- #11 – Affiliate Marketing
- #12 – Self-Service Machines
- Examples of Passive Income
- Passive Income Taxation
- Frequently Asked Questions (FAQs)
- Recommended Articles
- Passive income meaning describes a consistent source of income other than employment or business, and it requires little to no effort to start and maintain. It provides individuals with an added layer of financial security during loss of job, early retirement, and economic crisis.
- Effective passive income investments are high-dividend stocks, real estate investment trusts (REITs), exchange-traded funds (ETFs), mutual funds, fixed-income financial instruments, real estates, high-interest savings accounts, peer-to-peer lending with self-charged interest, or acting as a silent working partner in a business.
- Passive revenue, much like active income, is taxable but works differently and depends on the income source, such as rental properties and business or trade activities.
- Rental income is taxed differently from income from businesses or trades and cashback credit card rewards.
How Does Passive Income Work?
Passive income is quite appealing for everyone as it boosts their earnings and that too without much effort. One can create and maintain an alternative income stream by investing a little money or time in a product or something. It also provides extra financial security to an individual against unwanted situations, such as loss of job, early retirement, and economic crisis caused by factors like the COVID-19 pandemic. In other words, having various income sources acts as a safety net in case of an emergency.
Popular passive income investments include high-dividend stocks, dividend index funds, exchange traded fundsExchange Traded FundsAn exchange-traded fund (ETF) is a security that contains many types of securities such as bonds, stocks, commodities, and so on, and that trades on the exchange like a stock, with the price fluctuating many times throughout the day when the exchange-traded fund is bought and sold on the exchange. (ETFs), fixed-income tradable instruments, like bondsBondsBonds refer to the debt instruments issued by governments or corporations to acquire investors’ funds for a certain period., bond market index fundsIndex FundsIndex Funds are passive funds that pool investments into selected securities., real estate investment trusts (REITs), rental properties, and high-interest savings accounts.
Additional passive income strategies are peer-to-peer lending with self-charged interest or acting as a silent partnerSilent PartnerA silent partner is a business partner who invests in a business and becomes a part-owner of it with limited partnership liabilities. As the investor, they get a significant share in the company profits, which becomes the source of their passive income. in a business or enterprise. Interest earned for a loan offered to a limited partnership can also yield extra income.
Recently, a decline in fixed deposit interest rates in Indian banks due to the COVID-19 pandemic has forced consumers and investors to focus on passive sources of income to gain profits. The emergence of new-age investment options, such as fractional real estate investment, cryptocurrenciesCryptocurrenciesCryptocurrency refers to a technology that acts as a medium for facilitating the conduct of different financial transactions which are safe and secure. It is one of the tradable digital forms of money, allowing the person to send or receive the money from the other party without any help of the third party service., and peer-to-peer (P2P) lending, are attracting millennials. The reason behind this is the simplicity and higher yields offered by these options.
Fractional real estate investment is suitable for retail and NRI investors because of its affordability and better capital appreciation. Crypto staking allows investors to trade anytime and benefit from price appreciation. Furthermore, unlike fixed deposits, traders’ funds are not locked in staking.
Ideas Of Passive Income
Generally, earning money without providing a product or service is known as passive revenue. Among various passive income ideas, here are a few which an individual can use to create an alternative income stream:
#1 –Space Rentals
Owning land, commercial property, storage space, or farmlands can be the best way to generate income based on rental values. However, land leasing income is not eligible for passive revenue.
#2 – Royalties
An individual or company, or licensor can get royalty payments for the use of their intellectual properties or copyrighted works, such as books, music, videos, or other original works by another party.
#3 – Asset Leasing
Leasing tangible assets, such as vehicles, boats, equipment, furniture, can lead to earning passively. The income from the lease includes payments of interests plus the principal amount from the lesseeLesseeA Lessee, also called a Tenant, is an individual (or entity) who rents the land or property (generally immovable) from a lessor (property owner) under a legal lease agreement. (for a particular duration).
#4 – Trade Or Business Activities
Some business and trade activities generate passive revenue when there is no active participation by the owner. Per IRS, dedicating more than 500 hours to passive activities qualifies for material participation.
#5 – Starting Franchises
Starting a franchise or becoming a part of an established brand and operating under a proven business model can generate passive revenue.
#6 – Infopreneurship
It involves online sale and distribution of information, knowledge, and expertise that can help earn passive revenue over time. It could be developing online courses, recording podcasts, writing blogs and e-books, and producing videos on YouTube. Once the online content gets enough traffic, users can monetize it by selling digital advertisement space.
#7 – Fixed Deposits In Banks
It is an old method of creating extra income. Due to low-risk factors, many people rely on low-interest fixed deposits from banks for profits.
#8 – Invest In Financial Products
Most tradable instruments such as bonds produce dividendsDividendsDividends refer to the portion of business earnings paid to the shareholders as gratitude for investing in the company’s equity. or interests that may increase over time and act as passive revenue. Alternatively, preference should be given to high liquidity mutual fundsMutual FundsA mutual fund is a professionally managed investment product in which a pool of money from a group of investors is invested across assets such as equities, bonds, etc with short lock-in periods for more turnovers.
#9 – Network Marketing
Selling products via an auto-ship or automatic ordering program in network marketing means the individual will make future payments for a single product sale. Consider a sports personality lending their name for promoting a brand. In this case, the brand will ask the sportsperson to invest in its product on an ongoing basis.
#10 – Self-Service Businesses
A self-service business, if operated through outsourcingOutsourcingOutsourcing refers to contracting out specific business processes to a third-party or specialized service provider, i.e., an individual or company. and automation, will give a high-yielding passive revenue.
#11 – Affiliate Marketing
Be it blogging or creating online videos or podcasts, an affiliate marketing program could prove to be a good source of passive revenue.
#12 – Self-Service Machines
Investing in some self-service machines include ATMs, laundromats, internet kiosks at airports, hotels, cafés, retail stores, hospitals, food trucks, vending machines, self-service storages, and automatic carwashes can result in alternative income.
Examples of Passive Income
Given below are some examples of passive revenue:
Alice has a rental property worth $140,000 before depreciation and amortization, and she generates an extra income from it. If the total depreciationDepreciationDepreciation is a systematic allocation method used to account for the costs of any physical or tangible asset throughout its useful life. Its value indicates how much of an asset’s worth has been utilized. Depreciation enables companies to generate revenue from their assets while only charging a fraction of the cost of the asset in use each year. and amortizationAmortizationAmortization of Intangible Assets refers to the method by which the cost of the company's various intangible assets (such as trademarks, goodwill, and patents) is expensed over a specific time period. This time frame is typically the expected life of the asset. are $80,000, she owned $60,000 as net taxable incomeTaxable IncomeThe taxable income formula calculates the total income taxable under the income tax. It differs based on whether you are calculating the taxable income for an individual or a business corporation.. In the case of the 37% tax bracket, she pays a tax of $22,200. After comparing $22,200 to the amount earned, i.e., $140,000, an effective tax rate of 15.86% is seen.
George has an Internet kiosk that provides him with a passive source of income. Internet kiosks are usually self-contained and completely automated. Additionally, these kiosks operate 24/7, allowing consumers to use them whenever they choose. It finds use in Internet browsing and emailing, gaming, laser printing, and various office software applications.
George can digitally sell ad space and even post adverts using the kiosk software. To maximize profits, he places the kiosk in a high-traffic area with high consumer demand. George introduces the pay-per-use facility. Also, he configures the payment processing software in the kiosk to accept payment by coins, credit cards, or cash without the need for a cashier.
Passive Income Taxation
Passive income is applicable for certain taxes like active income earned from a full-time job or business or trading. However, it works a bit differently, and the taxable amount depends on the income source. For instance, the interest gained on a property sold or rented generates a passive revenue that can incur taxes.
The tax levied on the rental income differs from that derived from business or trade activities and cashback credit card rewards. Although the tax rate for alternative income is similar to active income, deductions are likely to lower net taxable income. It is worth noting that only profits from passive activities are eligible for tax deductions in the event of a loss.
Professional tax consultants can help determine specific tax situations based on the passive sources of income. They may also provide information on recordkeepingRecordkeepingRecordkeeping is a basic accounting stage that teaches us how to keep track of monetary business transactions with the goal of keeping a permanent record of all transactions, knowing the correct picture of assets-liabilities, profits and losses, etc., keeping control of expenses with the goal of minimizing expenses, and having important information for legal and tax purposes. and documentation requirements for filing the appropriate tax return.
Frequently Asked Questions (FAQs)
Passive income is the money flow created by an individual with minimum or no investment, effort, and supervision. Multiple extra income streams require an upfront investment and some amount of labor in the beginning. After some time, the income increases, and the individual receives steady profits.
Some examples of passive revenue include:
– Rental property investments
– Stock market investments
– Blogging, e-book writing, music, and video production
– Affiliate marketing
– Royalties on intellectual properties or copyrighted works
– Acting as a social media influencer
– Sale of stock photos, etc.
A laundromat is a safe, effective, and tried way to make some extra money. It requires low maintenance. People in their mid-50s should consider investing in laundromats because of the minimal maintenance costs. As a result, laundromats are ideal examples of passive revenue sources. The functions of the washing machines and dryers are both automated here. Other chores, such as cleaning and maintenance, can readily be outsourced, minimizing the oversight required.
This has been a guide to Passive Income and its meaning. Here we discuss how passive income investment works along with its strategies and ideas. You can learn more from the following articles-