Passive Income

Updated on March 11, 2024
Article byRamya Puttaparthi Tirumala
Edited byAshish Kumar Srivastav
Reviewed byDheeraj Vaidya, CFA, FRM

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.

Passive Income Benefits

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Key Takeaways

  • 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.

Passive Income Investment

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Popular passive income investments include high-dividend stocks, dividend index funds, exchange traded funds (ETFs), fixed-income tradable instruments, like bonds, bond market index funds, 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 partner 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, cryptocurrencies, 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.

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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:

Passive Income Ideas

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#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 lessee (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 dividends or interests that may increase over time and act as passive revenue. Alternatively, preference should be given to high liquidity mutual funds 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 outsourcing 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:

Example #1

Alice has a rental property worth $140,000 before depreciation and amortization, and she generates an extra income from it. If the total depreciation and amortization are $80,000, she owned $60,000 as net taxable income. 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.

Example #2

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 recordkeeping and documentation requirements for filing the appropriate tax return.

Frequently Asked Questions (FAQs)

What does passive income mean?

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.

What are examples of passive income?

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.

Can laundromats yield good passive income?

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-

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