How to Earn Passive Income
How would you feel if you didn’t have to work to make money? It would be amazing, right? That’s what passive income is all about. If you’ve been looking for ways to generate a sustainable and passive stream of revenue, we’ve got you covered.
In this post, we’ll learn all the different aspects of passive income. By the end, you’ll know where to start and what to expect in terms of return. Without further ado, let’s jump right in.
What is Passive Income?
Although the term is self-explanatory, we think you should know a little more about what it is. Earnings from limited partnerships, rental properties, or any other business where you are not actively involved are considered passive income.
Is there is a restriction on how much you can earn or how many streams can point to your bank account? NO! You can earn as much as you want as long as your sources are credible, legit, and you follow the IRS guidelines.
And that’s the beauty of passive income. You need to put in a little effort at the beginning of the venture and enjoy the results for years to come. Another great thing is that the IRS treats passive income differently in terms of taxes! We have a section where we talk about taxes and passive revenue toward the end of the post!
According to the IRS, passive income is ‘net rental income or income from a business in which the taxpayer does not materially participate.’. If you’re not sure what material participation is, let us help you.
Material participation is a set of tests that the IRS uses to determine whether you’re an active or a passive partner in a business. In general, there are 7 tests that go into the process. All you have to do is pass just 1 to be an active partner! And if none apply to you, it is considered a passive income.
Your participation in a business is determined by the hours you log in a year. You need to work at least 500 hours for a business to become an active partner. As an active partner, you get to claim an offset on your salary when it comes to taxes. When your work hours go below 500 in a year, you are declared as a passive partner.
Types of Passive Income
Believe it or not, there is a classification system for passive incomes as well! In general, there are three types of income. Self-charged interest, rental properties, and material participation in a business.
When you lend money to any partnership directly or through an S Corporation, the interest on that loan is considered as a passive loan by the IRS. Self-charged interest, to be precise. S Corporations are business entities that can pass the income directly to the shareholders without paying the federal corporate taxes. But it has to meet certain criteria by the IRS first.
Except for a few instances, all income from rental properties is considered passive income. And that’s why you see so many people opting for real estate investments. It’s a great way to generate income as well as get deductions from taxes.
So, what are the few instances where rental properties are considered an active income? When you lease out land for money. The lease payment you receive is considered active income because you are holding onto the property for profits. Also, if you’re a real estate professional i.e. hold a realtor license, all of your income is considered active income.
Learn how to invest in real estate step by step
No Material Participation
When you only invest in a business to get a percentage of the earnings without having to do anything with the operation of the business, it’s is considered a passive income.
For example, if you invest $200,000 in a departmental store and get into a contract with the owner to receive 5% of the net income, you have a passive income stream right there.
Why Should You Invest for Passive Income?
It’s a great question to ask. If you’re well off what you make in a year, why would you invest to generate passive income revenues? Well, our answer would be, why not?
If you can maximize your income by utilizing your existing assets and sparing a little extra time, you should take every opportunity to make money from it.
If you’re not convinced yet, here are some solid reasons to get a passive source of income now!
It’s a Foundation for the Future
Warrant Buffet once said, “If you don’t find a way to make money while you sleep, you will work until you die.” It might sound cliché, but when you give it enough thought, it starts to make sense. Even historical data says the same thing.
Passive income is very valuable against all other sources of income where time is traded for money. For example, a $100 passive income a month equals having $30,000 invested with a 4% return every year! The 4% return is quite conservative when you compare it to the 8% return for S&P 500 index from 1957 to 2018.
What does all of this data mean? It means passive income is the answer to a sustainable and financially stable future. You can gradually build up wealth while you put your time into the active work hours.
When you do it for long enough, you can feel the confidence building up in yourself that you can withstand any financial crash. As you have solid ground below your feet, you can live off of the secondary funds if something was to happen to the economy. The Coronavirus pandemic is a prime example of such a scenario.
It’s a very different feeling to see money in your accounts when compared to getting your salary credited at the end of the month.
Goals Become more Achievable
It may be different for all of us, but we all have goals. And most goals require money to reach. Whether it’s a dream for a forever home, a brand new car, or a college fund for your kid, passive income can help tremendously.
While you grind for every dollar you make through your active job, your passive stream will accumulate over time. And a 5-year long goal may be achieved within 3!
Even if it’s a financial goal for you as an individual or as a family, you will be there sooner than you’d expect. It’s a great sense of accomplishment that only passive income can provide.
Freedom is very loosely valued in today’s world. We’re all bound to schedules and deadlines that we must maintain. We’re always stressed and it’s taking a toll on some of our health as well. That’s where a passive income comes into play.
The surplus on your income gives you more freedom to fine-tune your approach toward life. You get a little more time to take care of yourself. The stress-free feeling is more valuable than any other asset in the world. More than freedom, passive income opens doors that were always locked for you.
Retire When You’re Still Young
We can refer to the Warrant Buffet quote again at this point. Such an inspirational line, isn’t it? Through passive income, you can retire early. Unless you’re a workaholic, early retirement means the enjoyment you’ve always been looking for. You can spend more time with your family, travel the world, or get back to unattended hobbies after a very long time.
Passive income builds your wealth from the ground up and gives you the option to quit your day job early. If you plan everything right, this might the turning point of your life.
More income means more savings. Unless you increase your expenses with the added stream of money, you can save a significant amount over time. And it’s excluded from your financial goals and retirement plans. A proper passive income source will give you the ability to improve your living standards as well as save more for the future.
How to Create a Passive Income Stream?
The limit is your imagination. You can make so much money from so many sources. If you’re worried about the IRS guidelines, don’t be. The area for passive income is broader than what the IRS covers. And even if your income is considered as active income, you won’t have any trouble paying the taxes. But it will remain passive to you because you won’t be investing any of your time into those once they’re up and running.
So, what can you do to make a passive income? Let’s find out.
Affiliate marketing has always been the go-to for people who want a great source of passive income. If you’re not familiar with what it is, you become an ’affiliate’ in an existing network and promotion third-party ‘merchant’ products or services in exchange for a commission.
You can promote the products through your affiliate website or a YouTube channel, whatever works best for you. You will provide the ‘affiliate link’ to your audience and when they purchase from your link, you get a commission, sometimes as high as 75%!
Such a popular network would be ‘Amazon Associates’. You can generate affiliate links and promote various products to earn up to 10% in commission depending on the category. The luxury items pay the most but they have a low sales volume. Opting for something in the middle would be ideal.
ClickBank is another popular medium but it’s only for digital goods i.e. music, e-book, videos, and so on. You can earn 75% as a commission on this network as the production cost is minimal.
In terms of effort or investment, all you need to do is build a sustainable audience. You can do it by providing great content, whatever you are good at. If you are good at writing, create a blog website. If you’re good at expressing yourself, go with a YouTube channel.
When your audience has trust in you, they will click the link eventually. And if you did your targeting right, the clicks will convert to sales. The best thing about affiliate links is that they are evergreen. As long as your content is on the internet and someone buys from your link, you keep getting the commissions. No questions asked.
Selling Products that Contain Information
If you’re good at something particular, why not sell it to others who want it? For example, if you are particularly good with a language, you can create video courses out of it and sell them to the people in need. A great way is to attract a mass audience through free content and redirecting the interested ones to the paid version. It’s known as the ‘freemium’ business model.
Every time someone buys your course, it’s a confirmed sale that generates you an income. And it will be on the internet forever. All you did was create the course one time.
However, you need to make sure that the quality of the product is top-notch. The competition is crazy when it comes to digital products. So, you can only expect to get make a passive income through selling your products when you provide great value for the money.
The same principle goes with e-books, copyrighted music, video clips, and so on. You put an upfront effort to reek benefits for years to come.
Dropshipping is one of the most amazing ways to make a passive income from ecommerce vendors. You don’t have to manage stocks or handle them, the ecommerce will take care of it. All you have to do is work as a representative for the business.
You list the products on your website and the dropshipping client will do the rest. The most famous example would be Shopify. If you search on Google or YouTube, you’ll find hundreds of tutorials to learn how to dropship.
Another popular fulfillment platform is Ecwid ecommerce. It’s a cheaper alternative to Shopify with all the features you need. It integrates with WordPress, SquareSpace, or any other website seamlessly. Once your inventory is up and running, your task is to click a few things every time you make a sale.
Real Estate Investment
Coming out of the online genre, we have landed right on top of real estate investment. Real estate is one of those genies that very few people have discovered. There is a misconception that real estate investment is very expensive and not for everyone.
The reality is, anyone and everyone are welcome into the real estate market. You don’t have to be a realtor to deal with properties. And it’s one of the best sources to generate a sustainable passive income.
- Renting Out Your Property: If you have a property somewhere that you don’t use, you can put it up for rent. Especially if it’s a tourist-oriented region, you can earn a lot from short-term rentals through Airbnb or similar platforms. You can rent your property to long-term tenants as well.
- Buying and Flipping: If you don’t own a property that you can spare, why not buy one? Or lease, at least. Buying and flipping cheap houses is one of the easiest ways to make a very good profit. And when you pay the price upfront, you don’t even have to think about mortgage payments or interest rates!
- Buying and Holding: The prices of properties only increase over time. So, if you invest now, you are looking at guaranteed profits when you sell it in the future. And if you put it out for rental, you will keep generating profit until you make the sale.
- Lease: If you’re not willing to take the risk of owning a property, why not lease it and earn a passive rental income? A lease contract often comes with a pre-set value for the property and you can buy it for that price when your lease ends. It’s an amazing way to build equity over time.
- REITs and RELP: Real Estate Investment Trusts and Real Estate Limited Partnerships are crowdfunded approaches in investment. It eliminates all need to buy, manage or sell properties. If you’re a particularly busy individual and have a substantial amount of money lying around, investing in REITs and RELPs will yield amazing passive returns.
The bottom line is, opportunities to generate passive income streams from real estate are endless. Depending on how much time and money you can spare, you make a ton of money from buying, developing, renting, and selling properties.
Stock Market Investments
We all know what kind of gold mine the stock market is. The majority of the people who lose money on stocks are either not aware of what they’re doing or misjudged an opportunity for a threat. But when you take an informed step, profits are almost guaranteed.
Investing in the stock market is a surefire way to generate a passive income without ever leaving your home. You can either go for the capital gains or the dividend approach, depending on what suits your needs best.
- Capital Gains: Capital gain is classified as an increase in capital value. Whether it’s stocks or real estate, you get a piece of the pie when the price increases. However, the investment must be sold to gain profit. For example, if you buy stocks for $10 a piece and sell them for $15, you got capital gain by selling your share.
- Dividends: The concept of dividends is fundamentally different from capital gains. When you invest in a company’s equity, you get a percentage of the profit as a shareholder. You don’t have to sell your stocks to get your dividend. For sustainable companies, the price to buy your place is quite high. But you get periodic returns. It’s a good idea to stay away from higher-yielding dividends against a low investment. It means the company will become unsustainable soon.
When passive income is the primary focus, you should always reinvest your dividends or capital gains into the market. You are essentially increasing your net worth by increasing your capital in the stock market. It’s very similar to investing in your own house to increase its value over time. And when the time comes for you to retire, you can sell your shares for a great profit.
The best strategy you can follow here is to buy and hold. You invest now and forget about it for years to come. Unless the company is dissolved, your shares will increase in value due to inflation adjustments. And when the time comes, you can unload the bulk.
High Yielding Savings Account
If you have enough cash lying around, why not put it into a high-yield certificate of deposit (CD). Also known as saving accounts, some banks will offer amazing interest on your deposits. You can increase the deposit amount as you work hard on your day job and collect payments from the passive ones, only to increase the interest you receive.
It’s one of the safest options to generate a passive income. The only downside is that you must have a hefty amount of cash ready for deposit. But it won’t be a problem if you follow our guide to generate multiple sources of passive income.
If you’re not too concerned about how your car looks, why not rent it out for advertising agencies? The culture of the mobile advertisement has become very popular in recent years. Essentially, an advertisement agency will wrap your car in ads and pay you monthly as a reward.
But it’s not as easy as it sounds. Factors like your car’s make and model, your usual driving behavior, the locations you drive to, etc. will be heavily evaluated by the advertisement agency. If everything checks out, your car will become a source of your income as well.
Renting Our Household Items
Do you have a spare car that you seldom use? Or, a set of power tools? Or, maybe a large cooler that you used once when camping? Make a list of such items that you have lying around collecting dust and rent them out to people.
If you live in a community-oriented neighborhood, start with your neighbors. Let them know that you have these items and they are welcome to borrow them when they go camping. It’s a fantastic way to bond with your neighbors as well as make some money on the side.
Taxes and Passive Income
Do you remember we said taxes are calculated differently for passive income by the IRS? No income goes tax-free and it’s true for passive income as well. However, there are many factors that influence the amount you need to pay.
For example, if you invest in a business as a silent partner, the tax will be different than what you have to pay for affiliate marketing earnings. It depends on the type of job and how many hours you log.
Your best bet is always to consult with a tax lawyer before you start investing for your passive income. If you have to pay a lot in taxes, the income source may not be the right choice for you. And no one but a tax lawyer could point you in the right direction.
In general, you should open a retirement account against a business to be on the safe side. To do that, you need a TIN (Tax Identification Number) from the IRS. Then, you need help from a broker to create your retirement account.
The most popular ways are SEP IRA and solo 401(K) accounts. Both accounts are taxed differently and have a different annual maximum. So, again, talk to a tax lawyer to get the best out of your passive income.
How Many Passive Streams Should You Have?
As many as you want. Unlike active income, there are no NDAs or other restrictions to stop you from investing. You can utilize your time and money in various sectors to create as many passive income streams as you can.
For example, you can do affiliate marketing and stash the income directly into your high-yield savings account. This way, your passive income from affiliate marketing is generating interest, another effective passive stream.
In another example, you can use your car advertisement money to create even better content for your affiliate marketing website by taking help from professional writers or influencers. It will increase the likelihood of more sales and more passive income!
Just like these two, you can create multiple combinations of business ideas and investment plans to maximize your revenue. The idea here is to reach your financial goals as early as you can to retire and have a glorious life.
No matter what we do in life, the ultimate goal is to make as much money as we can. So that we can provide for ourselves and our families, and hopefully the next generation. With the increasing competition in workplaces and inflation, it’s getting harder and harder to make those dreams a reality.
And that’s where passive income comes in. if you follow our guide carefully and generate at least one sustainable passive stream, you will thank yourself in the long run.