Active vs Passive Investing (Real Estate Strategies!)
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Active vs Passive Investing (Real Estate Strategies!)


– All right guys, we’re
gonna play a little game. It’s called active versus
passive real estate and which one is better. (upbeat country music) Subscribe to the YouTube channel. Click the bell notification icon so you know when a new video is uploaded. Tax laws are changing all the time, the laws are changing all the time, that’s why you’re first to
know, you’re first to grow. And so I’m just gonna
kinda lay it out to you in a couple of ways, so a lot of times I like to use analogies, so let’s just say that every
time you did x activity, boom, you got smacked in the head. Eventually, you’re gonna
realize don’t do that. It’s kinda like the dog that’s there or the cat or, I have cats, so lets say that they keep jumping up
on the counter, loud noise, “Hey, move”, that’s letting
them know to skedaddle, and eventually if they ignore it then you give them a
little pat on the hiney and try to get them out of there, get some newspaper,
make some noise, right? That’s the little whack,
taxes are like that. Taxes are no different, and
active income is the whack. And the reason in that
little whack and what it is, is you get ordinary tax treatment, and in addition you’re also gonna get old age death and survivors
and Medicare top it, also called the Self Employment
Tax or Social Security. Then you look at the other side. On the other side is,
you get a little nook, then you go over here, like
let’s say the cat’s doing good and you pet him or the
dog and you give him a little biscuit or something. That’s the called an ‘Attaboy.’ So you get a little ‘whack!’ And then you get a little ‘attaboy.’ And you gotta decide which ones you want. In the tax world you’re
getting this little whack every time you’re getting
active ordinary income. In real estate what is active income? And let’s just kinda look at it. I’m going to use red
because it’s kinda bad. It’s not necessarily good. So for active income you’re going to have your real estate agents -whoops,
it’s making some noises. Real estate agents, you’re
going to have your brokers. They’re making money. Whew, it’s loud today. Ah, you have your brokers, you
have flippers, wholesalers. You have your flippers,
you have construction, you have developers or I’m
gonna call them dealers. Anybody that buys property
with the intent to resell, then it gets this bad treatment
and this bad treatment really boils down to a
few different things. You have active, meaning
you have social security. So what is called active
social security tax or better yet, what is called
S E self-employment tax. You’re getting hit on old
age, death and survivors and Medicare on every
dollar that you’re making. It’s ordinary income which
means the more you make the higher the percentage
of what they take. So the more you make the more they take. So this is all bad stuff. So the active income is
good in a couple of ways because it shows it’s good for loans. So that’s a good thing. It’s, ‘Hey I have active income.’ They want to see active
income and I can contribute to retirement plans, so I can fund a 401K IRA out of this type of money. Now let’s contrast that to passive. And on the passive side we have, and I’ll use a different color for this, let’s say I’ll use orange
because it’s happy, happy. Orange will be our happy number. So our passive, really
easy, you already know it has no self-employment
tax, so no S E tax. You also get to take preciation against it so you have your depreciation, uh, if you don’t know what that
is, uh, oops depreciation. If you don’t know what depreciation is if I make 10,000 dollars on real estate let’s say I have rents come
in and I have 10,000 dollars of real estate my net
taxable income is zero. If I have -10,000 dollars
because I have no rental income I don’t get to offset my active income unless I qualify as an exception which is called a real
estate professional status which is a topic for a different day. The cool thing about this is
when I’m doing passive income and passive income are
rents, royalties, interest, dividends and capital gains. Those are your passive sources. Those are not, self-employment tax, when you are looking at capital gains you can even have long-term
capital gains treatment which is capped at 20
percent Federal income tax no matter how much you
make that’s the cap on it. Um, if you are getting paid dividends it’s capped at 20 percent. It’s like there are a few little nuances if you have futures 80 per
cent of it is where there’s a 60-40 rule, 60 per cent
acts as long term, short term you know, there’s some little
things, but for real estate, we’ll just zero in on that one, we care about the no self
E, uh, self-employment tax, no depreciation and
then the type of asset, because a lot of these tradeable
assets, I can generally trade my real estate for more
real estate and avoid tax. So it’s called a 10-31 exchange
where I can literally say I’m going to sell a million
dollars of real estate and so long as I buy a
million dollars of real estate I pay no tax. You cannot do that over here. You cannot do something else
like, so that’s a huge one. I cannot 10-31 exchange, so
I’m gonna put like right here there’s no 10-31 on active income. There’s another thing that
you can’t do and that is over here on this passive,
I can do installment sales. So this is a big smiley face, so I can do an installment sale. I can take that tax hit over time. So if I sell something
over a 10-year period let’s say I sell a piece of real estate over a 10-year period, I can
be recognizing that tax hit over a 10-year period,
like I would literally have part of that money coming back
as tax free which is my basis part of it is depreciation
of any depreciation recapture on any depreciation I took
which is capped at 25 per cent, it’s not 25 per cent it’s
your tax bracket capped at 20 per cent. Plus I’d have long term capital
gains plus I’d have interest all of those would get factored in and I would take them
over a set period of time. I cannot do that over here. You do not get, so there’s no installment and that’s a big one in real estate. Because a lot of times we sell property we want to carry the note? You do an owner carry,
you want to make sure that you’re over here. You wanna make sure it’s passive. Is there a way to make active
uh real estate into passive or vice versa, is there a way? Yes, you actually have to
do an arm’s-length sale. So you have to be very deliberate about converting something over. A great example is our friends
over there doing Airbnbs. Because Airbnb is an active, is active if it’s seven days
or less, the average rental. Then that’s going to be over here. If it’s more than seven
days, eight days, beyond, you’re passive. So, how do you, you know, so
what the heck are we gonna do? Well you either make
sure that you’re doing long-term rentals which you
can be very deliberate about. You go in opening your eyes
saying, ‘I want to get all this good treatment, I want my
depreciation,’ and all that or we create new tax
payers, an active tax payer like a corporation to
be the active tax payer and then I make myself the passive and I rent long to the
corporation and let it have all the guests and all the fun stuff. Anyway, that’s topic for another
day but you get the idea. So let’s go back and
just do a quick review. If you’re in active, if
you’re active in real estate so you’re a real estate agent,
broker wholesaler, flipper, dealer some sort of developer,
construction, whatever, you’re getting hit with ordinary income and you’re getting hit with
that self employment tax you have to do things to reduce it. We haven’t gotten into that,
there are ways to reduce it retirement plans, there are
certain types of investments, there’s giving money away
there’s lots of deductions and all those things that we’re gonna we’re gonna use to push down
that tax hit to take it away. It’s kinda like rolling with the punch. If you know the punch is
coming, if you roll with it, it’s not gonna hurt you nearly as bad. Then we, passive side. Passive side is awesome because we avoid a Federal tax completely,
the self-employment tax which is old age death and
survivors and Medicare. It’s 15.3 per cent on your dollars. There is a phase out on a portion of it on 12.4 percent phases
out at about 120,000 but it’s a pretty hard hit
if that’s what you’re making. Your depreciation. You really want to get depreciation
and it’s only available on the passive side on
the investment property and you get to do installment
sales so that’s like, that’s our happy place. So that’s a good old attaboy that’s like, ‘oh that’s good,’ that’s
the dog getting the bone. And we don’t want to get
the newspaper on our hiney. That’s the active income,
so if you ever have to think about active versus passive
income in real estate just know that the holy grail for
the wealthiest people in this country, the top two
percent, top one per cent is passive income. You can look at their tax returns, you can look at the tax
data that the IRS provides and the richest folks
have a significant portion of their income coming
in off of passive sources as opposed to active in fact
the minority of their income less than 40 percent on
average comes out of this side. So what does that tell us? It means go towards the passive, it’s our friend in real estate. I hope that gives you
a little bit of a clue. If you need any guidance on
this always talk to somebody that knows what they’re doing. Always talk to good tax folks. If you need guidance on this
you can always talk to Anderson Our information should be
attached to this video. (fun piano music)

About Gregory Ralls

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6 thoughts on “Active vs Passive Investing (Real Estate Strategies!)

  1. Thank you for this video. I saw on another channel a gentlemen mention that you should have separate LLCs for your passive RE endeavours and your active RE endeavours. Do you agree and why? My question pertains to California specifically

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