📈 What do investors want? Tax free passive income

In our previous issue, I asked readers to take a brief survey about what you’d like to see more of in Private Capital Insider.

In today’s issue, we’re going to do a quick review of how the survey results break down…

As well as some of the most frequently requested topics people want to learn more about (hint: it's paying less taxes and increasing passive income).

So without further ado, let’s get into it. 

-Jake Hoffberg

P.S. We are pausing the Weekend Edition in December, but will continue with our weekday edition through the holiday season.

P.P.S Looking for back issues of Private Capital Insider?

Go here to read everything we’ve published.

The Generational Wealth Code Survey: A Brief review of what our readers say they want

First off, a big thank you to everyone who took the survey. 

I’ve been in the industry long enough – and read enough surveys – to have a pretty good idea about what investors are interested in…

But as W. Edwards Deming's once said: “In God we trust. All others must bring data.”

So let’s turn to the data and see what our survey results turned up.

Here’s a quick breakdown of the age ranges of our 76 survey respondents. 

For anyone who has worked in financial services-related industries, the most obvious (and consistent) things people say when it comes to money are…

• Active Income: I want to work fewer hours and make either the same (or more) income from my job – This is all about getting leverage using other people’s labor. 

• Passive Income: I want all my monthly expenses to be covered so I no longer have to work for money – This is all about getting leverage using other people’s money.

• Generational Wealth: I want to protect my assets from harm, decrease (or eliminate) taxes, and transfer my wealth to the next generation – This is where you start to build the infrastructure required to build your own Family Bank and achieve true freedom (i.e., trusts, corporations, and nonprofits).

Next, we asked what people are planning to do with their portfolio allocation model – over the upcoming 12 months, are you buying, selling, or holding Public Markets, Private Equity, Real Estate? 

Not surprisingly, a lot of our readers are looking to increase allocation to Private Equity.

Also not too terribly surprising, given the market conditions for Real Estate, many are either holding or decreasing allocation…

But I was surprised to see what is basically a split decision here on Public Market allocation…

I thought for sure Private Capital Insider would have a more biased readership – investors in a 60/40 portfolio and looking to relocate to something more closely resembling the Tiger 21 member allocation. 

I’ll probably run another survey in December that has more explicit questions about asset allocation model (and what our readers are planning on doing with their model in 2024).

Here are my thoughts about these results

While I’m never surprised that people who are at or near retirement age tend to be far more interested in money/investing than younger age brackets…

It’s a reminder that for many of our readers, they are no longer in a position where they’ve got time on the clock to accumulate assets and figure out their retirement plan.

Instead, they have probably already stopped working, are living on a fixed income, and dealing with the scary implications of inflation and market crashes on their finances.

That’s why it’s no surprise to see that year after year, retirees' biggest fear is “running out of money before they run out of life.”

After that, the major concern is almost always something involving the surviving spouse, and their ability to maintain their lifestyle after the other has passed.

For this reason, as people get older, they tend to be more risk-averse, and prioritize capital preservation, income, and estate planning. 

If you’re in this bracket – and you already have enough money – this is a relatively straightforward proposition…

All you need to do is talk to an estate planning attorney, get your assets structured into some sort of trust, and invest in income-producing assets.

But what happens if you DON’T have enough money saved? Or you otherwise can’t get a big enough yield to cover all of your expenses?

This means you are either going to have to go back to work and earn a wage to cover the shortfall…

Reduce your living expenses and taxes…

Or possibly increase the risk in your portfolio, in pursuit of bigger returns.

In my opinion, this is a good reason to never stop earning an income for as long as you live.

And almost always, this means building (or acquiring) a business that you can continue to participate in and earn an income from.

This isn’t to suggest that I think you should work until you die (unless you like it, of course)...

But as Charlie Munger once said, “the first rule of compounding is to never interrupt it unnecessarily.”

This means if you don’t have sufficient cash flow… 

You will likely have to sell out of a quality long-term asset in order to cover short-term consumption needs.

Not only does this interrupt compounding… it requires you to pay taxes, fees, and transaction costs.

PLUS! One of the fastest ways to get a return on investment is through an investment in your earnings potential.

This means that reading books, taking courses, attending seminars, or hiring coaches to help you increase your active income can produce some of the best ROI – especially if you don’t have a lot of money to invest. 

So what types of skills and information should you focus on acquiring?

Learning sales, marketing, and coding are all pretty valuable skills to have… especially later in life when your health is in decline.

But if you ask me, if your goal is to win the Game of Money, that means learning how to play the game the way BANKERS do.

And that means shifting as much of your income from the ACTIVE bracket into the PASSIVE bracket.

Passive income includes earnings derived from a rental property, limited partnership, or other enterprise in which a person is not actively involved. 

While these money-generating ventures may have initially required some effort, they now generally pay out automatically, without the recipient breaking out a sweat.

But Bankers get a special cheat code that allows them to recategorize their income based on somewhat of an accounting sleight of hand.

The Internal Revenue Service (IRS) has specific rules for what it calls “material participation,” which determine whether a taxpayer has actively participated in a business, rental, or other income-producing activity.

There are seven material participation tests that, if any one has passed, you have materially participated: 

• You participated in the activity for more than 500 hours.
  
  

• Your participation was substantially all the participation in the activity of all individuals for the tax year, including the participation of individuals who didn’t own any interest in the activity.

• You participated in the activity for more than 100 hours during the tax year, and you participated at least as much as any other individual (including individuals who didn’t own any interest in the activity) for the year.
  

• The activity is a significant participation activity, and you participated in all significant participation activities for more than 500 hours. A significant participation activity is any trade or business activity in which you participated for more than 100 hours during the year and in which you didn’t materially participate under any of the material participation tests, other than this test.
  

• You materially participated in the activity (other than by meeting this fifth test) for any five (whether or not consecutive) of the 10 immediately preceding tax years.
  

• The activity is a personal service activity in which you materially participated for any three (whether or not consecutive) preceding tax years.
  
  An activity is a personal service activity if it involves the performance of personal services in the fields of health (including veterinary services), law, engineering, architecture, accounting, actuarial science, performing arts, consulting, or any other trade or business in which capital isn’t a material income-producing factor.
  

• Based on all the facts and circumstances, you participated in the activity on a regular, continuous, and substantial basis during the year.

Basically, if you are involved in the operations of an activity on a standard, continual, and significant basis… you meet the definition of material participation.

But, like many things in the Game of Money, there are some loopholes built in that favor Capital over Labor.

Let’s start with the managerial loophole.

According to the IRS, your participation in managing the activity doesn’t count in determining whether you materially participated under this test if:

• Any person other than you received compensation for managing the activity (i.e., you hired a manager and pay them), or
  

• Any individual spent more hours during the tax year managing the activity than you did (regardless of whether the individual was compensated for the management services)

This means if you’re involved in a business where there is an actual person managing the business, and you are doing “other stuff,” you can categorize that work as passive income. 

Now let’s talk about the “work not normally performed by owners” loophole. 

This happens if both are true: 

• The work isn’t work that’s customarily done by the owner of that type of activity, and
  

• One of your main reasons for doing the work is to avoid the disallowance of any loss or credit from the activity under the passive activity rules (section 469)

This one is a bit weird, but basically, if you are putting in work to figure out what you can and cannot deduct from your taxes, that doesn’t count towards material participation.

Basically, you are getting paid passive income to do part time Banker work.

Last but not least, let’s talk about the “investor loophole” – Time spent as an investor will not count unless you can show direct involvement in the day-to-day management of the activity.

Work you do as an investor includes:

• Studying and reviewing financial statements or reports on operations of the activity,
  

• Preparing or compiling summaries or analyses of the finances or operations of the activity for your own use, and
  

• Monitoring the finances or operations of the activity in a non-managerial capacity

In other words, when you learn how the money business works – and how to play the game from the BANKER position – you get access to cheat codes that other players don’t. 

Keep in mind that, when it comes to tax reduction, active losses can only offset active income, and passive losses can only offset passive income. 

This means that, depending on a lot of factors regarding your current income mix, you might have a better net result by materially participating in certain businesses.

And if your goal is to reduce taxes, increase passive income, and pass on your wealth…

There’s simply no business like the money business.

Not only is it “work” you can do for basically as long as you live…

It’s a great “family business” that gives you a chance to talk about money, finances, and investing with the whole family (and hopefully have fun while you do it).