If you don’t want to work forever, you might want to look for ways to generate passive income. As the name implies, passive income doesn’t require toil to earn money. And much of the income you earn from passive sources is taxed at preferential rates. Translation: You keep more of the money you earn.
The catch is that generating passive income usually does require assets. But you may already own them.
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Indeed, an increasing number of online platforms have formed to help people generate passive income by renting out a wide variety of possessions that they already have. These possessions can range from big things like houses and cars, to a variety of things that you’ve probably never considered particularly valuable — your driveway, attic space, carpet cleaner or tools, for instance. Some also allow artists to earn royalties and licensing fees for the use of their art — another form of semi-passive income.
Taxation of passive income
It’s important to note that when you earn income from work, you’re subject to a host of taxes, such as state and federal income taxes, as well as “employment taxes” that fund the Social Security and Medicare systems. Passive income is taxed differently and, generally, less heavily.
In fact, some forms of passive income are not taxed at all. You can, for instance, earn thousands of dollars for renting out your personal residence for up to 14 days a year and that income is 100% tax free. (Beware, though, if you rent your house for even one more day, all that otherwise tax-free income gets thrown into the taxable column.)
Most other forms of passive income are taxable, of course. But unless you turn your passive income into a part-time business, you’ll at least avoid employment taxes on the revenue, says Mark Luscombe, principal federal tax analyst with Wolters Kluwer. Employment taxes, shown as FICA on pay stubs, amount to 7.65% of a worker’s wages and 15.2% of a self-employed person’s net profits.
Even when income from mostly passive activities — like renting your personal possessions — is classified as self-employment income, you can qualify for tax breaks unavailable to employees that are likely to drastically cut Uncle Sam’s take. Specifically, self-employed individuals can deduct all of the expenses required to earn this income before determining the taxable portion of the revenue. There’s also a special 20% deduction that further reduces the taxable portion of self-employment income, says Luscombe. But you’re well-advised to seek professional tax guidance to determine which rules impact which forms of revenue. The U.S. tax code is complex and full of landmines.
Myriad ways to earn passive income
How can you earn passive income? The most common way is to invest in dividend-paying stocks. In most cases, the dividends that you earn on long-held investments are considered “qualified,” which means they would be subject to a maximum tax rate of 20%. (That compares with the top tax rate of 37% for earned income, which is also subject to FICA tax.)
However, dividend income is rarely generous. The typical stock will pay between 2% and 4% of its value each year in dividends. That means it could take more than 20 years to recover your initial investment. That said, there’s no work involved in earning income with dividend-paying stocks. Other forms of passive income are more generous but somewhat less passive.
Earning royalties on art
For instance, if you’re a good artist — or even a clever slogan-maker — you can earn royalties or licensing fees by uploading your art and allowing it to be sold on various products, such as coffee mugs and iPhone cases, made by print-on-demand companies. These companies, the best of which include FineArtAmerica and Society6 make, market and mail the products. But they license the art needed to decorate them. Artists set their own royalty rates. The print-on-demand operation simply adjusts the price of items to reflect your take.
Thus if a t-shirt or puzzle costs $20 to make, and you set your royalty rate at 20%, t-shirts with your design would sell for $24. And you’d earn $4 each time one was sold. Since your investment is your time, you’d need to make 5 sales to earn $20 for each hour you spent on the design. Additional sales once you recover the cost of your time, throw off additional revenue without additional work.
(You can sign up with Society6 here.)
Earning rental income on residential real estate
You can also earn semi-passive income by renting out all or a portion of your personal residence. Let’s say, for example, that you list your house to rent while you take a two-week vacation. If you list on Airbnb, you can charge a nightly rate plus a cleaning fee. Airbnb will deduct a commission from your pay to compensate the platform for advertising your rental and collecting payment.
If, for example, you rented your house for $250 a night after Airbnb costs, the $3,500 you earned for those 14 days is 100% tax free.
This, too, is really semi-passive income since there is a little bit of work involved. You need to take photos of your home; list it on a website; respond to potential renters; and arrange to have your housekeepers do the cleaning. All together, the work portion of renting out your home is likely to take an hour or two per rental.
Notably, Airbnb is not the only site that will rent out your house. You can also rent your home to tourists through VRBO. And, you can rent to movie producers and event planners through Giggster, Peerspace, and Splacer, among others. These sites encourage you to charge by the hour, which can allow you to earn four-to-five times more than with Airbnb. or VRBO. But there are unique risks with having movie productions and events at your home, too. Be sure to collect a deposit for potential damages and consult your insurance agent. (You can sign up with Giggster here.)
If you don’t want to rent your house, but aren’t averse to letting people use your swimming pool, you can sign up with Swimply. But the same cautions apply.
Renting personal property
Of course, you don’t need a house or yard to generate rental income. Dozens of online platforms will help you rent out personal items.
FriendWithA will help you market personal items, ranging from sporting equipment to tools.
And, if you’ve got an extra car, you can rent that out to tourists through Turo.