What Is Passive Income?
Imagine if you could make money simply by sitting back and doing nothing. Believe it or not, it’s something a lot of people do every day. That money you earn 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 materialize on its own; it needs an up-front investment of money and time. The first step to accessing passive income is purchasing, creating, or contributing to assets that generate capital. 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 ventures. 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 take part in.
Advantages of Passive Income
Passive income is a critical component 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 every day. It’s limited in many 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 income potential takes a dive, too.
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 dependent on your paycheck and also offers you more flexibility to choose how you spend your time. Passive income can fund major financial goals, like retirement, or less significant ones, like debt payments.
Kinds of Passive Income
As mentioned above, you can create a passive income stream by purchasing, creating, or contributing to an asset that produces cash.
- Purchase: Passive income investments include dividend stocks, bonds, annuities, as well as rental properties. You can also purchase a small company.
- Create: You can create a product or service that generates money.
- Contribute: You can invest in an existing company or a limited partnership. You can even make an asset you already have available for sale or lease. Renting out a room in your home is one example.
What Are the Most Popular Ways to Make Passive Income?
Popular passive income strategies fall into three general 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 track of your investment portfolio, and collect your payments. If you don’t 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 volatile as stocks. The trade-off is that real estate passive income is usually less passive than you’d assume. Unless you employ a property manager, you will be coordinating maintenance and repairs, fielding occupant questions, and collecting rents.
- Online businesses: Those who are short on cash commonly seek 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 Actually 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 involved differs based on the passive income approach you pursue.
Invest in a trusted dividend stock, and you don’t need to do much at all. Just oversee your position, and you may collect 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 tactics to boost returns, for instance. That’s a position you ‘d need to manage closely since it will probably be quite sensitive to market and economic trends.
A small-business launch, which could have limitless return potential, typically 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 exact nature of the income.
For instance, 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, but you can deduct your mortgage interest and other costs as well as depreciation. Income from a company you manage is usually 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 activities. This is where the IRS definition of “passive” comes into play. The short story is that losses from passive activities 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 company you’re invested in but do not 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!