Passive Income

Passive Income

Income from a passive activity. Earnings derived from a rental property, limited partnership, or other enterprise in which the individual is not actively involved. Therefore, passive income does not include earnings from wages or active business participation, nor does it include income from dividends, interest, or capital gains. If you have a passive loss, you can use it to offset your passive income. This is important because you cannot offset ordinary income with passive losses.

Passive Activity

An activity in which you do not materially participate. Real estate rentals and limited partnerships are examples of passive activities. Passive loss rules apply to losses from passive activities.

Passive Loss

Loss from a passive activity. Passive loss rules limit the amount of passive loss you can deduct to the total of your other income from passive activities. There is a $25,000-per-year exception for rental real estate activities, subject to limitations for high-income taxpayers. Passive losses that have not been used as a deduction can be carried forward to later years until they are used completely or until you sell or dispose of your interest in the business.

The way to attain financial independence is through acquiring passive income.

Passive income is something that flows to you and is largely independent of the number of hours worked in a job.

It needs to be pointed out that there is really no such thing as completely passive income because every dollar of passive income must flow from some kind of work or effort in the first place.

For example, while rental income might seem to be passive income, the task of finding and investing in property, together with managing the tenant, filling in tax returns etc. is anything but passive!

A good example of passive income is royalty payments paid to musicians. They write a song once and are potentially paid a royalty each time the song is played. The initial act of writing and recording the song wasn’t passive, but the ongoing payments when it is included on music CDs (sometimes many years later) is. Just think of the Beatles!

The word ‘passive’ really means avoiding being paid by the hour.

Instead you seek to do some work today and leverage off it tomorrow. This leverage is in the form of receiving multiple payments without the need to work again.

For example, if you invest in a positive cashflow property then you hope that the work involved in finding and acquiring the property will create a positive income stream that will last until you sell the property. One days work now for a lifetime of return later.