What Is Passive Income?

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

Making money without working for it might seem too good to be true, and there is a catch. Passive income does not materialize on its own; it requires 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 a continuous stream of income you can enjoy over time.

Keep in mind that the IRS has a narrower definition of income from passive activities. For the purposes of your tax return, special tax rules apply if the income is derived from equipment leasing, rental properties, or a company you don’t materially take part in.

Benefits of Passive Income

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

Your work 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 manager’s perception of your performance. Even when you’re healthy and capable of working, there’s a ceiling to how much you can make. And, if your health fails, your paycheck potential takes a dive, as well.

Passive income does not have those limitations. You can earn passively at any age and in any health condition. A larger stream of passive income makes you less dependent on your paycheck and also 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 repayment.

Kinds of Passive Income

As noted above, you can create a passive income stream by buying, creating, or contributing to an asset that generates cash.

  • Purchase: Passive income investments include dividend stocks, bonds, annuities, as well as rental properties. You can also purchase a small business.
  • Create: You can create a product or service that produces money.
  • Contribute: You can invest in an existing business or a limited partnership. You can also make an asset you already own available for sale or rent. 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 upfront, keep watch over your investment portfolio, and collect your payments. If you do not need the cash flow right away, you can reinvest those dividends or interest payments to accelerate your income growth.
  • Rental properties: Owning property 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 often less passive than you’d assume. Unless you hire 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 want to start a small business that will eventually produce passive income. There are numerous opportunities in the digital space, from e-commerce stores that drop-ship products to blogs and online courses. This is a longer-term approach given that these companies are usually resource-intensive at the beginning.

Does Passive Income Truly Require “No Work”?

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

Invest in a reputable dividend stock, and you do not have to do much at all. Simply oversee your position, and you could collect a 2% or 3% return on your investment for many years.

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

A small-business launch, which might have limitless return potential, often requires even more time and energy. You might 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 specific nature of the income.

For instance, ordinary dividends are taxed as ordinary income, yet qualified dividends are taxed at long-term capital gains rates. Rental income from real estate properties is also taxed as ordinary income, but you can deduct your mortgage interest and other costs as well as depreciation. Income from a business you manage is often 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 activities can not counter your ordinary income. You either need to carry those losses forward or counter 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 take part in.

With Mission First Capital, you can start your investment journey alongside other military members and veterans! 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 let’s invest today!