| Cash flow formula makes it easier to determine | | | | put us back onto the positive cash flow track. |
| whether a rental property is worth buying. Uncle | | | | Tax deductible rental loss formula: |
| Sam is kind enough to give you as a rental | | | | Rental Income - Operating Expenses - Debt |
| property investor a great deal of tax breaks by | | | | Interest Payments - Depreciation |
| allowing you to deduct your rental property's | | | | Tax saving formula: |
| operating expenses and mortgage payments. | | | | Tax Deductible Rental Loss x Your Federal |
| Even better, you can deduct depreciation, a | | | | Income Tax Rate |
| "phantom" expense that does not actually occur. | | | | In this example, rental income is still $11,160 and |
| The cash flow formula is, Rental Income - | | | | operating expenses are $3,000. |
| Operating Expenses - Debt Payments. However, | | | | Mortgage payments usually consist of principle and |
| your TRUE cash flow is calculated by adding back | | | | interest payments (P+I), unless you have an |
| the tax saving Uncle Sam graciously gives you. | | | | interest only mortgage. The lender will provide |
| Your tax saving is as a result of your rental loss | | | | you a 1098 form containing the mortgage interest |
| deduction. | | | | amount for your tax purposes. This amount is |
| Cash flow formula: | | | | gradually decreased as the mortgage term |
| Rental Income - Operating Expenses - Debt | | | | matures. Here we use $6,560, the first year |
| Payments | | | | interest payment amount for our example. |
| True cash flow formula: | | | | Depreciation is a phantom expense that is not |
| Rental Income - Operating Expenses - Debt | | | | actually paid out from your pocket. The IRS rule |
| Payments + Tax Saving | | | | states that the life of a residential property is 27.5 |
| Let's continue with an example, a $150,000 single | | | | years, and only buildings rather than land is eligible |
| family house with $120,000 loan amount at 30 | | | | for depreciation. The value of land and building |
| year 5.5% interest rate. That means debt | | | | ratio is usually 1:4. So the building of our $150k |
| payments of $8,176 annually. | | | | single family house is worth $120k. Divide $120k |
| For $1,000 monthly rent, that is $12,000 annual | | | | by 27.5 and you get the annual depreciation of |
| rental income. You can reasonably factor in the | | | | $4,364. |
| vacancy rate depending on the rental market. | | | | Federal income tax rate varies by individual but a |
| Let's assume 7% vacancy rate, this yields $11,160 | | | | good estimate is 30% in most cases. |
| ($12,000 x 93%) annual income. | | | | With these, the tax deductible rental loss is |
| Operating expenses are the necessary expenses | | | | $2,764. (Rental income $11,160 - Operating |
| paid in order to operate the property. Such | | | | expenses $3,000 - Debt interest payments |
| expenses include property tax, insurance, and | | | | $6,560 - depreciation $4,364). The tax saving is |
| repairs. A reasonable figure for this property is | | | | $829 ($2,764 x 30%). |
| $3,000. | | | | As you can see, this turns your annual cash flow |
| With all these numbers, we now have a negative | | | | from -$16 into positive $813. |
| $16 annual cash flow. However, a tax saving can | | | | |