What Is Passive Income and How Do I Build It?

what-is-passive-income

If you’re a forward-focused thinker, you may be dreaming about leaving the workforce to enjoy an easier life in retirement or you might even be considering retiring early. But a dream without a plan is just a wish.

To put some wheels on that dream, you need to consider passive income. There are plenty of different passive income options and explanations of how to build it. If you’re new to the idea, I’m about to break it down for you.

What Is Passive Income?

Passive income is money you earn in a way that requires little to no daily effort to maintain. Some passive income ideas—like renting out a property or building a blog—may take some work to get up and running, but they could eventually earn you money while you sleep.

Why Build a Passive Income?

Your income is your greatest wealth-building tool—a tool that typically requires your active participation in the form of a full-time job. You know what I’m talking about! Even if you love your job, I’m willing to bet you wouldn’t mind earning some extra income without the blood, sweat, tears, and time commitment of another job. In fact, there are several benefits. Building a passive income:

  • Increases your wealth-building plan
  • Creates an opportunity to retire early
  • Protects you from a complete loss of income if you lose your job
  • Provides an additional source of income when you’re no longer able to work or if you outlive your retirement fund

How Much Money Can I Make?

Passive income generally won’t make you wealthy overnight, so forget about any get-rich-quick schemes you’ve heard of. But steady, profitable passive income options can build some serious money over the long haul. We’re talking anywhere from a few thousand dollars to hundreds of thousands of dollars—depending on the income stream.

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 business and passive income does not.

An 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 an 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 categorized as passive but do involve work.

But, that doesn’t mean that these revenue streams are not lucrative.

Blogging or starting your own internet business is common for income that is miscategorized.

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.

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