What Is Passive Income?

Imagine if you could make money just by sitting back and not doing anything. Believe it or not, it’s something many folks do every day. That money you make with little to no effort is known as passive income, and it places you on the fast track to financial independence.

Making money without working for it may sound too good to be true, and there is a catch. Passive income does not appear on its own; it needs an up-front investment of money and time. The first step to accessing passive income is buying, creating, or contributing to assets that generate cash flow. If all goes as planned, your reward for that initial investment is an ongoing stream of income you can enjoy over time.

Remember that the IRS has a narrower definition of income from passive endeavors. For the purposes of your tax return, special tax rules apply if the income is derived from equipment leasing, rental properties, or a business you don’t materially participate in.

Advantages of Passive Income

Passive income is a crucial component of financial independence. Compare passive income to the money you make in a paycheck, and you can see why.

Your job income depends on you showing up and carrying out tasks each day. It’s limited in several ways– by the hours in the day, your health, your age, your company’s policies on raises and promotions, and even your boss’s perception of your performance. Even when you’re healthy and capable of working, there’s a ceiling to how much you can earn. And, if your health fails, your income potential takes a dive, as well.

Passive income doesn’t have those restrictions. You can earn passively at any age and in any health condition. A larger stream of passive income makes you less reliant on your paycheck and provides you more freedom to choose how you spend your time. Passive income can fund big financial goals, like retirement, or less significant ones, like debt payment.

Types of Passive Income

As noted above, you can establish a passive income stream by purchasing, creating, or contributing to an asset that produces cash.

  • Purchase: Passive income investments consist of dividend stocks, bonds, annuities, as well as rental properties. You could also buy a small company.
  • Create: You can create a product or service that generates cash.
  • Contribute: You can invest in an existing company or a limited partnership. You can also make an asset you already have available for sale or lease. Renting out a room in your house is one example.

What Are the Most Popular Ways to Make Passive Income?

Popular passive income strategies fall into three basic categories:

  • Traditional income investments: Fixed-income and dividend-paying securities are popular sources of passive income because they require very little work. You do the research up front, keep watch over your investment portfolio, and collect your payments. If you do not need the cash flow immediately, you can reinvest those dividend or interest payments to accelerate your income growth.
  • Rental properties: Owning real estate for rental income is also appealing because you can finance the property inexpensively with a mortgage. Also, the property’s value isn’t as unpredictable as stocks. The trade-off is that real estate passive income is typically less passive than you ‘d think. Unless you employ a property manager, you will be coordinating maintenance and repairs, fielding tenant questions, and collecting rents.
  • Online businesses: Those who are short on cash often seek to start a small business that will ultimately produce passive income. There are many possibilities in the digital space, from e-commerce stores that drop-ship products to blogs and online courses. This is a longer-term approach since these businesses are typically resource-intensive at the beginning.

Does Passive Income Really Require “No Work”?

Passive income does require work. However, much of that work is done at the start so you can enjoy the cash flows later on with less effort. The amount of work required differs based on the passive income strategy you pursue.

Invest in a credible dividend stock, and you don’t need to do much at all. Simply manage your position, and you could receive a 2% or 3% yield on your investment for many years.

As you pursue greater returns, the amount of work can increase. You can invest in a high-yield income fund that uses leverage and other aggressive strategies to boost returns, for example. That’s a position you’d have to manage closely because it will probably be quite sensitive to market and economic trends.

A small-business launch, which could have limitless return potential, often requires even more time and energy. You could put in full-time hours for months before the business is stable enough for you to step back from the front lines.

How Do I Pay Taxes on Passive Income?

This probably will not surprise you: The taxation of passive income is confusing. There are several sets of rules and exceptions that apply, depending on the precise nature of the income.

For example, ordinary dividends are taxed as ordinary income, but qualified dividends are taxed at long-term capital gains rates. Rental income from real estate properties is also taxed as ordinary income, however, you can deduct your mortgage interest and other costs along with depreciation. Income from a company you manage is typically subject to ordinary income tax, plus self-employment tax.

There is also a special set of rules governing the tax treatment of losses on passive ventures. This is where the IRS definition of “passive” comes into play. The short story is that losses from passive endeavors can not offset your ordinary income. You either need to carry those losses forward or offset them with passive income in the same tax year. This only applies if your income comes from real estate rentals, equipment leasing, or a business you’re invested in but don’t materially participate in.

With Mission First Capital, you can start your investment journey alongside other military members and veterans, just like you! If you have questions or would like to talk about potential partnerships or investment opportunities don’t hesitate to reach out. Give us a call at +1 (844) 632-3863 or visit our website MissionFirstCapital.com to learn more and invest today!