What is passive income

Question

What is passive income?

Thomas S. · Answer

Earnings an individual derives from a rental property, limited partnership or other enterprise in which he or she is not materially involved.

Generally a bit of a stretch in reality to include residential rental properties but under the definition they are included.

None I have ever owned were passive from my perspective.

Clayton Mobley · Answer

@Olivia Darling As you can see from your answers so far, the definition of 'passive' can be different from person to person. It is correct to say that, in IRS terms, 'passive income' is income from activities in which you do not materially participate, as @Thomas S. noted. @Scott Heitman's example of the fishing boat is a great one in terms of underlining the meaning of 'materially' in this context. He does not do the fishing or captain the boat, he basically trades some of the income from that venture in exchange for having other people do all the actual work (smart!). The 'activity' is the fishing, which he doesn't actually do, but he still earns income from it without 'materially participating' in that activity, so it is 'passive income'. My guess is that this income is a lot more passive now than when he first started, however, because you have to research the people you work with in any investment type. Once he gets everything in place, however, Scott basically just takes a boat ride every once in a while and then gets paid at the end - which is pretty cool way to generate income that I haven't seen on these forums till now.

In real estate investment, most people refer to income from Rental Properties as 'passive income'. But as @Anthony Dooley rightly pointed out, if you DIY a rental investment (meaning you do everything on your own) it is anything but passive. There is a ton of labor that goes into scouting deals, hiring contractors, overseeing rehab, finding tenants, etc. The upside is that if you know what you are doing, you can get a higher ROI than if you pay other people to do those things for you - just like Scott could earn more from fishing if he didn't split the proceeds with the fishermen and instead went out and caught the quota himself. So there is trade-off in terms of profit, and whether that trade-off is worthwhile depends on your personal goals - do you want your investment to be like a job, or do you want to keep all your time and energy for other pursuits in exchange for a portion of the profits? Neither is right or wrong, it's all about personal priorities.

Now, a lot of people will say that Turnkey is the ultimate 'passive income' investment, which is both true and false. While it is true that a good turnkey company (which is a company that handles everything from finding props to rehab, then sells the properties to investors and manages them as rentals long-term) with a strong property management team should enable you to basically just collect rent every month, that only happens after you've made the investment. Prior to cutting a check, you're going to be doing a TON of work looking at different markets, vetting providers, comparing numbers, and looking for reviews from current clients, and flying out to meet the one or two teams on your shortlist. That part is anything but passive. Of course, you could make it pretty passive by just investing with the first provider you see, no questions asked, but I don't think anyone would recommend that :)

I hope that helped consolidate the varied answers you'll see to this question. BP is an AMAZING place for research and education - but there's a wide range of opinions on literally everything, for better or for worse.

All the best,

Clayton

Ali Boone · Answer

@Andrey Y. I've had a very different experience with turnkeys but I don't want to take up this thread...if we keep talking we should take it elsewhere since this isn't what the post was originally about. But either way...everyone will always have different experiences and everyone should find the thing that works best for them! Having awareness of what that is, per the individual, is a great step.

Sylvia B. · Answer

What is passive income?The answer depends on if you are talking about reality or for tax purposes.

Reality: You give someone money to use and they pay you. You have no input into how the money is used, except perhaps in a general sense.

Tax Purposes: Income from rental properties or from a business in which you do not actively participate.

Andrey Y. · Answer

Ali,

I myself have underestimated the true full time owning even a Turnkey property takes. It's easy to do when you love real estate like you and I do. The time you spent researching Turnkey providers, talking on the phone with them, due diligence, talking to lenders, scanning and gathering financial documents, looking at inspection reports, closing, talking to PM about repairs, etc. took hours, probably dozens of hours each property, if you're lucky.

After the dust had settled, it's possible to spend 2-3 hours on a property per year, but you need to factor all the backend and frontend time. It's easy to forget. I was lying to myself for the last 3-4 years that my real estate investing has been passive. Although it has helped me grow my net worth tremendously, I am diversifying into equities which are liquid and pretty passive. I still love real estate but what's right is right.

Ali Boone · Answer

Not sure why so many people haven't been able to have passive income properties. All of mine are. But I hire property managers to manage my properties so I'm mostly hands-off.

No investment property will be 100% hands-off, but I rarely spend more than a couple hours a year dealing with mine... which is pretty dang passive if you ask me.

It's completely dependent on what you buy and how you set it up to have it managed. If you landlord, that's no passive. If you flip, that's not passive.

True passive income could come from something like notes, rental properties run my property managers, if you have a business setup to flip properties where employees do most of everything, etc.

Here's some random info that might help-

https://www.biggerpockets.com/renewsblog/2013/11/0...

And a little more comparing different strategies and how active each one is-

https://www.biggerpockets.com/renewsblog/2014/12/1...

Hope that helps!

Scott Heitman · Answer

Own longline fishing quota. Lease it out to a catcher boat. Walk onboard. Wait till the vessel catc hes your quota then offloads and sells. Split the proceeds. Bank youŕ share. This is an example of how I earn passively.

Anthony Dooley · Answer

Rental property is not passive. You have to find the deal, buy it, manage it or the manager, track expenses for taxes, pay for expenses, pay taxes, pay insurance, and eventually exit. An example of passive would be to put money into a mutual fund and forget about it for decades. It makes money and you do nothing.

Account Closed · Answer

Passive income is the returns on an investment for which you do absolutely nothing. You make the investment and pay off the money, and the returns come to you with no effort on your part.

I too have never made a real estate investment that was truly passive.

Andrey Y. · Answer

Fair enough. I was just trying to point out that it's easy for us youngsters to significantly underestimate how much time we actually spend on real estate, considering all the aspects. If you like something, it doesn't seem like it takes long at all.

And yes, 20 hours is a long time to me. For two reasons, I'm lazy and I like to slack off, and my specialty at work pays $400/hr.

Turnkey properties don't return what you think they do. Take your $300-400 per month in 'cash flow' and cut it to at least half due to CapEx. Planning on exiting before any major expense and/or hoping nothing happens the first 5 years is more akin to hoping than investing, imo.

What is passive income

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