What is this thing you’ve heard about called passive income?
There are actually two definitions, a popular definition among personal finance people and a technical definition used by the IRS for tax purposes.
Here’s the popular definition:
Passive income is recurring money earned with little, if any involvement in the business producing the income.
It’s the money that you can use to pay your expenses while you focus on what you want to do in life.
For many people, it’s the holy grail.
It’s how most people fund their financial independence and early retirement.
There’s also the technical definition:
The definition of passive income from the IRS is money received from business activities in which you are not actively involved or real estate rental income if you’re not a real estate professional.
In this post will cover the following topics:
- The differences between passive and active sources of money
- How does passively making income work?
- What are the ways you can start building passive sources of income?
- Some examples of passive sources of earnings
Passive income has become a popular term with people often incorrectly categorizing streams of revenue as nonactive income when they are really just less-active income or almost-passive income.
We are going to discuss passive activities to make money using the popular definition and touch on a few technical aspects.
We hope this discussion will help you better understand passive sources of money.
How Does Passive Income Work?
Passive income is pretty simple, although there are differences depending on the form of income.
With passive income, you own a business or asset which generates revenue for you.
You may own all or part of a private business which you do not actively manage but receive all of the net income.
Or, you may own stock in a public company that pays out a dividend.
Another common, form of passive income is real estate rental properties.
You own the property and rent it out to other people and collect income.
There are slight variations but passive sources of revenue involve ownership, little or no involvement, and money from the ownership.
What Are the Ways that You Can Start Building Passive Income?
The whole idea of passive income is creating a revenue stream that you don’t have to actively manage.
You could start your own business but unless you can hire people to manage it, you’ll will not have passive income.
Generally, you receive passive income by investing your own money into a business or asset.
Going by the popular definition, you buy company stock that pays a dividend or you invest in debt that pays interest.
You could also invest in a private company that pays out earnings to each of the owners.
This is in line with the technical definition of passive income as long as you are not helping out the business.
Eventually, with passive
But, in most cases to own a source that produces money passively you have to buy it.
Unless given to you, the other common option is doing some active work and then turning that into passive income.
What are the Differences between Passive and Active Income?
Passive and active forms of making money have a few differences.
Business Involvement
The main difference is that active income involves you being involved with the
The easy example of active income is working for a salary.
If you have to spend time helping the business and your receive income, then it is active income.
An easy way to think about this is to think about how the income is being produced.
When you work at a company like Apple, your are exchanging your time for money.
But, when you buy the stock of Apple, you, in effect, own a piece of the company, exchanging your money for future cash flows and dividends.
Dividends are actually considered a different form of earnings by the IRS even though, under the popular definition they are passive income.
Meanwhile, real estate rental earnings are considered passive earnings by the IRS even if you’re involved in the business aspects.
Rental properties are a weird grey area where they may be passive depending on how you decide to operate it.
You could have a company operate the rental property for you and outsource all of the business functions.
Or, you could do all of the business functions like interacting with the tenants, repairing the home, etc.
So real estate can definitely be passive but it can also be less-active money.
Taxes
Active earnings and forms of passive money can have different taxes.
This is where things can become very difficult to figure out and where the popular definition and the technical definition clash.
You go to a website that says 30 ways to make passive income.
In reality, when it comes to pay taxes.
Some of those forms of income would be considered active income, others considered investment income, and some considered other income.
There are only a few forms of passive earnings that are taxed as passive actives.
Generally, if you receive cash directly from the business before it’s taxed, it is probably passive earnings.
As we said previously, dividends are not taxed as passive earnings.
Before you start thinking about which forms of “passive income” you want to use to build your wealth, consider the tax implications and do some research.
Turning Active Income into Passive Income
There are ways to turn active income into nonactive income in the popular sense that you receive money without having to actively work for it.
We’ve already discussed how you can actively or passively manage real estate.
You could also start a business and once it becomes profitable, hire people to manage the business for you.
What is Less-Active Income?
We define less-active income as all those revenue streams that are incorrectly
But, that doesn’t mean that these revenue streams are not lucrative.
Blogging or starting your own internet business is a common for of income that is mis-categorized.
Generally, there is a large amount of time that you’re going to have to devout in the beginning if you want to become successful.
Eventually, you may be able to work less on the business but you’ll still have to work on it.
The only way for it to become truly passive is by hiring someone to manage the business for you.
Final Thoughts
We like to go by the motto that if it involves time, it’s not true passive income.
And, passive money will usually require capital (money) to own the right to that money.
But, does anything really not involve time?
You’re probably going to have to devout at least a little bit of time to any investment you make to generate passive income.
The less time you spend on it, the more passive it is.
