Passive income is a term that’s used to describe several forms of revenue generation.
One type of passive income is earnings from investments, like an Airbnb rental property, dividends, interest on savings, or leasing a piece of equipment that you own.
But passive income can also be ongoing earnings from something you’ve previously created. It could be sales revenue from a digital product, like a prerecorded online course, or commission produced by affiliate marketing content, such as a YouTube video.
Depending on how passive income is earned, it may be taxed differently.
Dive into the full meaning of passive income, learn how it differs from active income, and get some popular ideas for setting up your own passive income business.
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What is passive income?
Passive income is revenue generated with minimal participation. It refers to earnings from investments or cash flow produced by an initial output of labor, with little ongoing effort.
Unlike active income, passive income doesn’t involve a straight exchange of time or labor for money. Instead, it consists of creating or buying an asset that will produce a return on investment at a later point.
There’s also a narrower definition of passive income used by organizations like the IRS. For them, passive income doesn’t include things like royalties or product sales.
They define passive income as earnings from a rental property or a business in which you don’t materially participate. Material participation means being involved in business operations on “a regular, continuous, and substantial basis.”
Is passive income a real thing?
Here’s a hard truth: Passive income models are rarely as passive as many people think. Significant upfront work or funds are usually required—like writing the book you’re going to sell, developing a curriculum for your online course, or choosing and purchasing a rental apartment.
Often, the work required to set up a passive income stream is unpaid, in hope that your efforts will be repaid over months or years.
There’s also the task of managing your content, services, or products. And, you may need to engage in marketing to ensure your offering reaches the eyes and ears of a target audience.
Add ongoing maintenance jobs and other types of business admin, and you might start to wonder why the word “passive” is used.
Despite these considerations, passive income remains a potentially lucrative revenue stream, which many people choose to pursue alongside active employment.
For online passive income models, ecommerce platforms like Shopify let you automate tasks like order fulfillment, reducing the time you need to spend monitoring your business.
Passive income vs. active income
Don’t think about passive income as a mysterious money hack where an entrepreneur sits on a couch while their laptop prints dollars. Instead, understand passive income as a description of where effort is located in contrast to other forms of work.
Income is considered passive when effort is front-loaded. In other words:
- Passive income is earned through an initial application of labor or financial investment, with compensation following for a sustained period.
- Active income, on the other hand, describes a reciprocal exchange of labor and revenue, where effort is compensated more or less immediately.
Both passive and active income require work, it’s just a case of when that work happens. Someone paid by a brand to write a blog post every month is generating active or earned income, while someone who writes 20 blog posts for their own website and monetizes them with affiliate links is generating passive income.
In contrast to active income, passive income is a riskier strategy. But it can be a good side hustle if you pick the right type of passive income for your skills and schedule.
What are the different types of passive income?
- Product and service fees
- Marketing and advertising commissions
- Business dividends
- Rental income
- Loan and lease repayments
There are two main types of passive income. The first type are things you create and then sell or license to receive ongoing revenue. Passive income from creations can include:
Product and service fees
Creating an app or software-as-a-service (SaaS) can generate passive income. Once the initial development is done, these digital products can continue to earn revenue without much additional work, especially if they’re subscription-based.
Marketing and advertising commissions
Affiliate marketing is another way to earn passive income. You promote other people’s products and earn a commission for every sale made through your referral link.
You can also earn ad revenue from videos you upload to a YouTube channel or money from sponsorships of Instagram posts or podcast episodes. Social media platforms allow you to monetize your content and earn passive income over time.
Earning royalties from a book you’ve written, a song you’ve composed, or a patent you’ve invented is another form of passive income. Every time someone purchases or uses what you’ve created, you get paid.
The second type of passive income is from investments, earned by lending your assets, funding businesses, or accruing interest. Examples include:
Investing in businesses can be another source of passive income. For example, if you buy shares in a publicly traded company, you can earn passive income in the form of dividends. You’re not actively involved in the day-to-day operations of the company, but as a shareholder, you’re entitled to a portion of the profits.
This type of passive income is classed as unearned income by the IRS and includes taxable interest and capital gain distributions.
Unless you’re a professional landlord, renting property is considered a form of passive income generation. After purchasing a property and renting it out, you may generate profits after deducting the mortgage payment and other expenses.
Loan and lease repayments
Leasing equipment and loaning assets can also generate passive income. You purchase an asset, lease it out, and earn income from the payments.
10 ways to generate passive income
Here are some popular passive income ideas:
- Design print-on-demand products
- Become an affiliate marketer
- Create online courses
- Sell digital products
- Get sponsored
- Dropship products
- Own a private equity
- Earn rental income
- Invest in the stock market
- Engage in peer-to-peer lending
Design print-on-demand products
Print-on-demand is a business model where you create custom designs for white label products. When a customer makes an order, your print-on-demand partner will print and ship the product on your behalf. You earn the difference between what you charged the customer and the supplier’s price.
If you can source popular products, create attractive designs, and reach prospects through an effective marketing strategy, you can use print-on-demand to generate passive income from your creative skills.
Become an affiliate marketer
With affiliate marketing, you partner with a company to promote their products or services. They give you a unique link to share; when someone clicks the link and makes a purchase, you earn a commission on the sale.
The hard work for affiliate marketers comes in finding the right products to promote, then reaching an interested audience. Popular affiliate marketing channels include organic search and YouTube marketing. Once you’ve found an audience, affiliate marketing income can be passive. As long as people are clicking your link and buying, you’re earning.
Shopify has its own affiliate program for creators, marketers, and those interested in inspiring the next wave of entrepreneurs.
Become a Shopify Affiliate
Join the program to grow your brand, access exclusive opportunities, and earn a competitive commission for each new business you refer to Shopify.
Create online courses
Monetizing and sharing your knowledge can be a lucrative form of passive income. Whether you’re a whiz at digital marketing or a master baker, there’s likely an audience eager to learn from you.
Online courses can take many forms. They could be recorded videos, allowing students to learn at their own pace. They might be in-depth ebooks for those who prefer to read. Or, they could be interactive lessons on a learning management system, offering a hands-on experience. You can even mix these formats to cater to different learning styles.
Once your course is up and running, it can earn income each time a new student signs up. That’s the beauty of online courses—you do the work once, but the earnings can continue long after, making it a solid choice for generating passive income.
Sell digital products
Selling digital products is an increasingly popular way to earn passive income. Unlike physical products, digital products are created once and can be sold an unlimited number of times without having to replenish inventory. They can range from music files and digital art to ebooks and software tools.
If you’re a musician, you could create background music for videos that people can purchase and use in their own content. If you’re a digital illustrator, you could create brushes, textures, or templates that other artists can use in their work. Designers might create fonts, icons, or online store themes.
The key is to identify a need for digital products within your niche. Once your digital product is created and listed on an online platform, it can generate income every time it’s downloaded or purchased.
Sponsorships are a form of passive income that apply to both online and offline activities.
Online, you could partner with brands that want to reach your audience. If you have a podcast, a company might sponsor an episode or a series of episodes, and pay you to mention their product or service during your recording. The same concept applies to blog posts, YouTube videos, or social media posts.
Offline, your activities or events could be sponsored. For example, if you’re an athlete, a company might pay you to use and promote their equipment. If you organize events or meetups, a company might sponsor these in return for advertising or promotion.
If you can establish a partnership with brands that align with your values and are relevant to your audience, they can provide a steady stream of income with minimal additional effort.
When you run a dropshipping business, your store doesn’t keep the products it sells in stock. Instead, when a customer buys an item, you purchase it from a third party who ships it directly to the customer.
With no ongoing inventory management or order fulfillment, dropshipping provides the opportunity to run a business with minimal ongoing effort. If you can identify trending products to sell, and partner with a reputable dropshipping supplier, this model makes starting an ecommerce business accessible and efficient.
Get started with a dropshipping business
Open a business without the hassle of managing inventory, packaging, or shipping.
Own a private equity
Owning a stake in a business can be a passive activity, depending on your level of involvement.
Private equity refers to any money you directly invest into a company, contribute to venture capital, or invest in real estate. These investments are often seen as risky, and most take years to generate returns. But they can be a good source of passive income if you’re looking for a long-term investment.
Earn rental income
The most common form of passive income comes from real estate. It often involves buying property and renting it out to a tenant.
Some would argue that being a landlord isn’t passive, because you have to maintain and upgrade the property. But, you could always hire a property manager to take care of the property or spend a few hours per month managing tenant requests and concerns.
The most maintenance-intensive part of owning a rental property is turnover, when one tenant moves out and another moves in.
Invest in the stock market
The stock market is one of the simplest ways to create passive income. As companies generate profits, they redistribute earnings back to investors in the form of dividends. You can invest in various dividend-producing assets such as:
- Dividend stocks
- Real estate investment trusts (REIT)
- Index funds
- Dividend exchange-traded funds (ETFs)
Investing in assets that yield dividends is simple. Sign up for an advisory or brokerage service, add money to the account, and buy one of the assets above.
Engage in peer-to-peer lending
Peer-to-peer (P2P) lending connects individual lenders and borrowers without going through a bank. It allows borrowers to get quick loans at a low cost. Interest rates vary depending on the borrower’s credit score.
4 benefits of passive income
Here are a few reasons why you might want to consider creating a passive income stream:
1. It lets you live and work from anywhere
Living and working from anywhere is possible when you are not dependent on a paycheck. Passive income gives you the flexibility that other methods of earning money cannot provide. You can work from anywhere while still maintaining your standard of living, which means you can travel or do other things.
2. It reduces stress and anxiety
Not having enough money to pay the bills is a major cause of stress for many people. With passive income, you can pay your bills without worrying about not having enough money. You have the financial momentum to manage yourself, your time, and your assets effectively when you have passive income.
3. It gives you more financial freedom
Passive income goes beyond earning extra money. With more than one income stream, you can pay for your living expenses without being reliant on one employer or dependent on others. It also gives you flexibility to spend time as you like, be it pursuing passion projects or starting a small business.
4. You may gain additional cash flow
Possible wealth creation is obviously the big draw of passive income. It can provide an alternative wealth option, accelerate early retirement, support a digital nomad lifestyle, and increase your net worth.
How much can you make from passive income?
The amount you can make from passive income varies widely. It could be just a little extra cash each month, or it could be a substantial yearly income. It all depends on what you’re selling and how scalable it is.
Take investing, for example. An ETF tracking the S&P 500 could give you an average yearly return of 8.31%. Residential rental properties? About 7.5% each year. Industrial real estate investments? Around 9.5%. All of these beat a high-yield savings account, which might earn you 1.5% per year.
Online content creators can earn a living through passive income, too. Personal finance YouTuber and author Frankie Calkins earned $800 in January from passive income streams, including YouTube channel advertising, book sales, and affiliate marketing, while another person made more than $100,000 from dropshipping ($6,000 alone on selling a plush elephant pillow for babies).
Revenue is entirely dependent on how much time, effort, and resources you put into building it, the scalability of your product, how much you’re selling it for, and how big the demand is for it.
Start now and generate passive income
There’s a good chance you already have assets you can use to create passive income—or a skill set you can leverage to make extra cash.
Remember, earning passive income isn’t easy. There’s an upfront workload that involves defining your goals, creating or buying an asset, and managing your business.
Once you set up passive income investments, whether they involve contributing to a new business venture or buying income-producing securities, you can earn more in the long run, with little to no effort.
Passive income FAQ
Is passive income taxed?
Passive income is taxed according to how the income was earned. It’s up to you to understand and abide by local income tax laws.
When it comes to passive income and taxation, here are a few reminders:
- Know how the IRS defines passive income. For the IRS, passive income is defined as either “net rental income” or “income from a business in which the taxpayer does not materially participate.”
- Know what counts as “material participation.” The IRS has a set of guidelines for what it calls material participation that determines whether someone has actively participated in business or other income-producing activity.
- Know when passive income is taxable. Passive income is usually taxed at the same rate as salaries, but it can receive different treatment from the IRS.
Disclaimer: This is by no means financial or tax advice. It’s best to consult an accountant to discuss your individual case.
How can a beginner make passive income?
The initial stages of generating passive income are the hardest, because that’s when you’ll be investing the majority of your time and energy. Creating your asset upfront involves coming up with a marketable idea, planning it, and actually creating it. If you’re investing, you need to save up money to invest in an asset, like real estate or stocks, then manage the investment after purchase.
Can you live on passive income?
If you manage your money well, you can retire early and live on passive income. Some of Udemy’s highest paid course creators earn $17,000 per month without doing active work. Investors can also live on their investment through real estate, P2P lending, and IRA or a 401(k) if they invest in dividend stocks over time.
How can I build passive income?
- Invest in a rental property.
- Create and sell digital products.
- Rent out your house.
- Become an affiliate marketer.
- Start a blog or YouTube channel.
- Invest in the stock market.
- Become a peer-to-peer lender.
What is the difference between passive income and unearned income?
Passive income includes earned income from rents, royalties, and contributions to limited partnerships. Unearned income includes things like inheritance money, gambling winnings, taxable interest income, ordinary dividends, annuities, and capital gain distributions.