Episode 58: Passive Income Is Not As Passive As You Think

Welcome to this week's What Works Wednesday! Today, we're diving into passive income. Despite the hype, there's a lot to unpack about what it truly means. We'll explore the definitions, pros and cons, and the differences between passive and active income. From real estate rentals to selling courses, we'll clarify misconceptions and highlight the real work involved. Join us to understand how passive income can fit into your financial strategy.

Transcript:

Welcome to What Works Wednesday. My name's Leland Gross. I'm your host. And today I want to talk about passive income. This ethereal phrase, passive income, that if you've spent any time online, you've come across a blog, a TikTok video, an Instagram influencer talking about generating passive income so you never have to work again and you fuel your life and don't have to do anything. You just make money. And passive income is really wonderful.

But I think there's a lot of misconceptions about it. And so I'm excited to dive into it today. I want to talk about what truly is defined as passive income. What are the pros and cons of it? And how do we think about it overall? I heard a quote from someone recently that passive income is a lot more work than you would anticipate, which I thought was funny because the innate idea behind something being passive is it's not active. It doesn't take a lot of work. I think in the last

couple years you've seen a lot of trending ideas around passive income with real estate rentals, having rental property to generate passive income to supplement your income, making money while you sleep, people selling courses for anything and everything. And you have to be careful. What really is passive income? Because real estate, even the same property being rented could be passive or active.

selling a course could be passive or active. There's not just this one blanket, like this action is passive, this action is active. And so what is passive income? Well, passive income is anything you don't work more than 50 % of the time on. So real estate, the reason why a lot of people, for them it's passive, is because they have a full -time job and they can document, I have worked X amount of hours per week

doing this other thing. And so this rental property I really don't spend a lot of time on. And so, great, it's passive income. Selling a course could be passive income, or they could be like, well, this is just clearly a stream of income you work really hard on. You're promoting it on Instagram, you're promoting it in your newsletter, you're doing all these things. So it could be passive if it's just out there generating income, or it could be active if you're really working to sell it, manage it, add to it.

run, you know, Fourth of July sales on it, things like that. So you have to be careful what you deem active versus passive. Now, what's the benefit of passive income? Well, the benefit of it is it avoids FICA tax or self -employment tax for people who are self -employed. So on active income, when we get paychecks, they've got our federal, our state income taxes taken out, and then it has our

Government benefits are Social Security, Medicare, Medicaid. If you're self -employed, that is in the form of self -employment tax. If you are W -2 employed, that's in the form of FICA, in which your employer also pays payroll tax on. So, with passive income, you're only going to pay the income tax, the federal and the state. You're not going to pay that added 15 % or 7 .5 % on Social Security

Medicare and Medicaid. So that's a benefit. You pay less taxes on passive income. But there's also cons to it. With active income, so real estate, if you're an active real estate investor, you're a real estate agent who also does rentals, well let's say you buy a rental, you can depreciate it, you invest money into it, and let's say the numbers work out to where in the first year you have a pretty sizable loss. Well,

Active losses get to be written off against active gains. So if, you know, one side of your business made $200 ,000, the other side lost 50, well, now you're only taxed on 150 because that whole loss was written off against your active income. With passive income, your losses are capped at 25 ,000. So if you lost 50 ,000, you only get to write off 25. So depending on which way the money goes,

Passive can be really great, can be not really great. But I think there's this misconception that I need to buy real estate, I need to create a course, I need to do X, Y, Z thing to create passive income if I'm not, I'm falling behind because I want to make money while I sleep. I want to like not have to work and make money. Well, even passive activities require a lot of work. If you own a rental property, you are a landlord. And I think people forget that.

I have clients who buy these real estate properties and yet I'm all for buying real estate. I think it's a great investment opportunity. But you just have to realize you're now a landlord. So if something happens, you're getting a call or you're property manage or you have to pay for property management, which is a cost. And they get the call and they just pass that call over to you and say, you now have to pay for all this money. It can be a lot of work to maintain these properties, to maintain renters.