Time is money. You’ve heard this countless times, but have you ever really thought about how this saying applies to your life?
When you work, you are literally exchanging your time for money. You can also trade money for time. When you take an unpaid absence from work or turn down a “gig” to hang out with friends, you are giving up money for more time to do something other than work.
However, making money doesn’t have to use your time. Money that is made without consuming any of the 24 hours you get each day is called passive income.
Passive Income Definition
The IRS has a rather strict definition of “passive income” for tax purposes. Broadly speaking, the term covers just about any (legal) way to use your money instead of your time to produce more money so that you can use your time to do other things.
Although much has been written about ways to generate passive income — after all, who wouldn’t be interested in making money without having to work for it? — many of the suggestions are really just work by another name.
For example, if something you created produces ongoing sales or royalties (such as a book you wrote or a song you recorded), that income isn’t passive. It is a result of your time and effort, even if it was done years ago. Selling your stuff on eBay also takes time and effort — it’s not passive.
Here’s a simple example of showing income that comes from work versus passive income: If you buy a cow, milk the cow, take the milk to the market and sell it, that’s work. If you give money to a farmer to buy a cow, milk the cow, sell the milk and send you a percentage of the proceeds, that’s passive income.
Here are examples of how to generate truly passive income, both Traditional and New Economy approaches. We also offer some overlooked ways to pad your wallet without lifting a finger.
Traditional Passive Income
Rental real estate — This is probably the most common source of passive income. You buy a property (such as a house, condo or small apartment building) and rent it out. The rental income requires no time or effort on your part.
However, it does takes time and effort to find tenants, make repairs, etc. So, you might pay a property manager a percentage of the rent to take care of those things for you. (Remember, time is money!)
Commercial real estate, such as small office buildings and strip malls, can also be a source of passive income. You could buy such properties directly. But the most common way for individuals to invest in commercial real estate is through a REIT (rhymes with “beat”). REIT stands for “real estate investment trust.” This is essentially a mutual fund that owns a mix of commercial real estate properties.
Shares in a REIT pay you income in the form of dividends, not rent. The value of the shares fluctuates with the value of the properties and is also impacted by other market forces. A big advantage of REITs compared to owning property directly is that REITs are traded on a stock exchange, so you can easily sell them if you need to raise money quickly. While this approach to real estate investing does not take up your time, REIT dividends do not qualify as passive income by the IRS.
Limited partnerships — Buying shares in a limited partnership (LP) is the other common way to generate genuinely passive income. Real estate developments and oil and gas drilling are the two most common types of publicly traded limited partnerships. While owning shares in an LP complicates your year-end tax filing, it can be a nice source of regular income. Note that a number of LPs are designed to generate losses that are advantageous to some taxpayers.
Bonds, bank CDs and other securities that pay interest — These investments are also considered by many people to be a source of passive income. After all, you don’t have to do any work to receive these interest payments. (Here are some of our favorite ideas for getting the most from CD investing.)
New Economy Passive Income
Rent out your place while you’re away — This twist on the traditional way of generating passive income with real estate eliminates the need to buy another property; you use the one you already have. There are many platforms for renting out your living space, such as Airbnb, VRBO and HomeAway. Be sure to check restrictions in your area.
Peer-to-peer lending — You can earn a high rate of interest by lending your money directly to individuals who may not qualify for a loan from a traditional source, using one of many online platforms (Lending Club, Prosper and others). You might support an entrepreneur or help a student with college costs. But know that many borrowers seeking loans through peer-to-peer lending are consolidating debt. You can earn around 8%–12% or even more. But beware: There is a risk the borrower will not pay back the loan.
Sell ad space on your car — Think of your car as a mobile billboard. It can generate income for you while you drive around. (The more you drive, the more you can make.) Be sure to go with a company like Carvertise that does not require any upfront payment from you.
Often Overlooked Types of Passive Income
Pay off debt — Reclaim all of the money you would have paid in interest on your debt. This can really add up over time. Since credit cards almost always have the highest interest rates, pay off those balances first.
Reduce water and energy consumption — There are dozens of ways to do this, at little or no cost. Lower your utility bills and keep more of your money. It’s like getting a raise just by remembering to turn off the lights.
Passive income allows you to have both time and money — that’s a sweet deal. Here’s to using them both wisely.