Perhaps you have heard this term “passive income” for the first time. I remember, quite a few years ago now, when I heard of the thing called passive income. It sounded nice but I wasn’t quite sure what it was, how to get it, or whether I wanted it.
Let’s demystify this and find out whether you too want some!
What Is It?
It is exactly as it sounds, an income that comes your way without you having to work for it. It just magically and passively shows up in your bank account.
Most of us are used to going to work and then getting paid. This is called active income. Income you derive by an activity and active participation in creating value.
Types of active income are sales, running and operating a business, jobs, consulting, etc.
Passive income on the other hand is derived through payments you receive from an asset.
The easiest and most well-known asset that provides passive income is real estate.
For example, you have a house, you rent it out, the rent check covers all expenses and there is something left over. That left-over piece is passive income.
Does Anything Involving Real Estate Count?
To discern whether you are making passive or active income, ask yourself if you have to do actual work to generate income. If the answer is yes, then it’s not passive income.
Passive by definition means inactive. And just because you can generate passive income through real estate, it does not mean that all activities associated with real estate are going to generate passive income.
For example, if you are a wholesaler or flipper (fix and flip a house, typically), you are actively participating in the industry. Your income, often derived by selling the property, is not considered passive, because you have to physically do work to make money.
Are There Different Ways To Make Passive Income?
Real Estate happens to be the most well known and easiest to explain, because most people have or live in houses (apartments, condos) so they can understand it.
Passive income can be derived by owning a business but not actively participating in it.
Other ways that you can generate passive income are candy and vending machines, residual income through many network marketing companies, affiliate marketing, books and other royalties, ATM ownership, etc.
Why Do Not Most People Have Passive Income?
I think majority of people are taught and trained to get a job and trade their time for money. This, also happens to be the easiest way to generate income, in the short term.
Passive income requires a different line of thinking that most of us haven’t been taught. It also requires some starting capital to purchase the assets and set things up. The time delay in getting income is what often stumps people in starting in the first place.
Most of us are used to getting results (and dare I say those that we want) right away. When that doesn’t happen, we give up.
Setting up passive income streams means that short-term you have to delay your gratification and be okay not making money for the short time (depending on the source of income this short time can be a few day before your rental pays you to a couple of years if your asset takes longer to build, set up, market, etc.).
Are Different Incomes Taxed Differently?
Most of us are familiar with the actively earned income (also called ordinary income) and taxation that happens with that particular way to make money. This type of income bears the highest taxation.
How much? Well they range, but it can be as high as 80% in some countries.
The next way to make money is through capital gains (also known as portfolio income). This income is achieved by selling an asset at profit. For example, you buy a stock at $10 per share and sell it at $15 per share. The $5 per share is profit and that profit will be taxed.
How much? It depends on how long you held the stock and what country you’re in, but it’s often less than earned income. In the US, the long-term capital gains have a range and for most individuals it’s 15-20%.
Finally, passive income is another way to make money and this type of income we’ve already explained above.
What is the taxation rate for this type of income? Again, it has a range and it depends, but it can be as low as 0%
One question remains: Will you take action to get it?
Interested to get started in real estate investing? Take Instant Wealth Through Real Estate for Beginners course.