The after-tax cash flow shows the total cash after expenses and taxes. When you start investing in real estate, it can be difficult to learn all the terminology. Moreover, it’s easy to feel overwhelmed by all the different calculations and analyses that seem important.
Determining Net Income
One of the most important first steps in calculating after-tax cash flow is determining the net income for the year. According to the IRS, rental income is “any amount you receive for the use or occupation of property.” Rental income can include any of the following:
- Regular rental payments: This type of ordinary rental income typically includes the regular rent you receive from monthly tenants.
- Advance rent payments: Rental income can also include any rent you receive before the rental period. A security deposit is also considered an advance rental payment.
- Payments for canceling a contract: Rental income can also include payments made by a tenant to you for canceling a lease before its specified term ends.
- Expenses paid by the tenant: If a tenant pays any repair costs or expenses that you should be responsible for, they are considered rental income.
Once you calculate the total rental income, you can find the net income by subtracting operating expenses. These costs can include maintenance, insurance, administrative expenses, debt service, and any other expenses incurred. However, tax costs or deductions should not be included here.
Determining Tax Amounts Due
Once you determine the net income, you can find out the tax amount you will owe on that income. The good news is that in addition to reporting your rental income, you’ll also be able to report the expenses and depreciation of your properties.
According to the IRS, you can deduct “ordinary and necessary expenses for managing, conserving, and maintaining your rental property.” Examples of ordinary and necessary expenses include:
- Maintenance
- Agent commission
- Utilities and management fees
- Insurance
- Legal services
- Interest
- State taxes
- Depreciation of properties
Please note that for federal tax purposes, you will report your rental income and expenses on Form 1040, Schedule E. The first part of this form is dedicated to rental properties and income.
You will need to report the following information:
- The actual address of the property
- The number of fair rental days and personal use days
- The type of property
- The rent received
- The expenses
Your net rental income is taxed at your regular federal income tax rate, which ranges from 10% to 37%. It is possible for your expenses to exceed your income – meaning you will owe no tax – but your losses will be limited by passive activity loss rules and at-risk rules.
You also need to keep in mind that depending on where you live, you may be required to pay state income taxes. The amount you will owe and how to report that income depends on where you live and the state where the property is located.
Calculating After-Tax Cash Flow
Once you determine the net rental income and the taxes due, you can easily calculate after-tax cash flow. The formula will be as follows:
After-tax cash flow = Operating income – Operating expenses – Debt service – Taxes due
A simplified version of the formula would be:
After-tax cash flow = Net income – Taxes due
Conclusion
Knowing how to calculate after-tax cash flow is an important part of real estate investments. This calculation gives you the most accurate insight into your income from properties. While looking at total income – or even net income – may give you some idea, it is not fully accurate unless all your expenses and taxes are included.
Frequently Asked Questions (FAQs)
How to calculate after-tax cash flow?
It helps you
After-tax cash flow provides a better financial picture of your investment. You can calculate after-tax cash flow by subtracting operating expenses, debt service, and taxes from total operating revenue.
How is cash flow from real estate taxed?
Rental income is subject to income tax, meaning it will be taxed at the same ordinary income tax rate as other income and may push you into a higher tax bracket. However, you can offset some of that with deductions on certain ordinary and necessary expenses related to the rental property.
What is cash flow before taxes in real estate?
In real estate, cash flow before taxes is the operating revenues minus your debt service. It’s similar to calculating after-tax cash flow but does not take into account any taxes you may owe.
Source: https://www.thebalancemoney.com/calculate-after-tax-cash-flow-2866787
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