How to Compute Taxable Income (or Loss) for Cash Flow After Taxes

taxable incomeThe profitability of investment real estate property, of course, is measured by the amount of cash flow the property generates. What a real estate investor always wants to know when considering his or her profitability from the property for any given year is “How much did I make?”

And this is resolved by considering the property’s cash flow plus or minus the investor’s taxable income or loss.

Taxable Income or Loss

To make this computation we must first determine the property’s net operating income (NOI). Net operating income is gross operating income (GOI) less operating expenses. For example, where a rental property generates an annual rental income of $205,993 and annual operating expenses of $41,718, its net operating income would be $164,275.

GOI – Operating Expenses = NOI
$205,993 – 41,718 = 164,275

Next, we would then deduct the annual amounts for loan interest paid, depreciation and amortization, and then add in any interest earned to arrive at the investor’s taxable income or loss. Okay, but let’s break down the various components and then show the formula. It will be more meaningful that way.

Interest Paid

The annual amount of interest paid on your loan during any given year is straightforward. For instance, if you made mortgage payments totaling $88,470 of which $23,552 was applied to principal, the amount of interest you paid during that year is $64,918.

Payments made – Principal reduction = Interest Paid
$88,470 – 23,552 = 64,918

Depreciation

Depreciation is more complex because it depends on the type of real estate being depreciated and what percent is allocated to improvements (land cannot be depreciated).

Depreciation (or “cost recovery”) is defined by the tax code as a “loss in value to a property over time as the property is being used” and owners are allowed by the tax code to take a tax deduction each year until the entire depreciable asset is written off. The amount of depreciation deduction depends on the income property’s “useful life” which the current tax code says is 27.5 years for residential property and 39 years for commercial (nonresidential property) real estate.

For our example we’ll keep it simple and just say that the amount of allowable depreciation taken for our income property during this given year was $23,076.

Depreciation taken = $23,076

Amortization

This refers to the process of taking a partial annual tax deduction for an item you are not allowed to expense in a single year and must amortize, such as “loan points.” Though you pay this premium in a lump sum the minute you close the loan you are required to amortize it over the life of the loan. Again (for simplicity sake) let’s just assume that the amortized points allowable by the tax code for our given year were $920.

Amortization = $920

Interest Earned

This concerns the interest income you might have earned on your income property or maybe on an escrow account that your lender required for real estate taxes and insurance. In this case we’ll simply assume that the interest earned is zero.

Interest Earned = 0

Formulation

Net Operating Income
– Interest Paid
– Depreciation
– Amortization
+ Interest Earned
= Taxable Income or Loss

or,

$164,275
– 64,918
– 23,076
– 920
+ 0
= 75,361

Cash Flow After Taxes

To arrive at the investor’s cash flow after taxes (CFAT) we must consider two other components that must be calculated first. Namely, cash flow before taxes (CFBT) and tax liability.

Cash Flow Before Taxes

This represents the income produced by the property without any consideration for the real estate investor’s income taxes. It is derived by subtracting the property’s annual debt service from its net operating income. For example, by subtracting the total mortgage payments of $88,470 (or debt service) illustrated above from the NOI of $164,275 the CFBT is $75,806.

NOI – Debt Service = CFBT
$164,275 – 88,470 = 75,806

This amount is typically shown in a real estate analysis and plays a part in our next computation, but it really doesn’t represent the cash the investor gets to pocket after Uncle Sam has taken his bite.

Income Tax Liability

This represents what the real estate investor will owe to the IRS for income tax purposes by virtue of owning the real estate investment. It is computed by multiplying the taxable income or loss by the investor’s marginal tax bracket. For example, if the investor falls into a 28% tax bracket then we would multiply $75,361 by .28 to arrive at an income tax liability of $21,101.

Taxable Income or Loss x Marginal Tax Rate = Income Tax Liability
$75,361 x .28 = 21,101

Formulation

That brings us to the more meaningful bottom line of cash flow after taxes – the amount of cash the real estate investor can keep after income tax – and explains why it’s essential for investors to determine.

CFBT
– Income Tax Liability
= CFAT

or,

$75,806
– 21,101
= 54,705

Final Thought

We illustrated a positive taxable income and therefore an income tax liability that reduced the CFAT. If it were a negative amount it would be considered a taxable income loss which means that the income tax liability would in turn increase the CFAT.

So You Know

ProAPOD Real Estate Investment Software provides two solutions that automatically make these calculations and includes them in the appropriate real estate analysis reports.

 

What is ProAPOD Real Estate Investor Software?

real estate investor softwareProAPOD INVESTOR 4 real estate investor software was developed so novice investors can skillfully and easily conduct a deep-level rental property analysis to really be sure whether the property is profitable.

This deep-level analysis solution includes the tax shelter and time value consideration required by experienced investors so you get the before and after tax cash flow data they use for your own investment decisions.

So you can quickly and easily analyze the profitability of an income property so you never have to merely hope before you make the investment.

Origin

An alternative to expensive seminar software. INVESTOR 4 was developed in 2006 after discovering that novice investors at investing seminars were being offered software solutions with minimal features for around $300. My idea was to provide these same beginner investors a software solution with over twice the features at a fraction of the cost.

In a Nutshell

Affordable “deep-level” real estate analysis. INVESTOR 4 does not include marketing elements. So it is ideal if you plan to buy and hold (perhaps to supplement retirement) because you get the deepest-level analysis for smart investment-decisions and save by eliminating robust features associated with rental property marketing you won’t require.

Special Features Include a “Formula Learning Center”

real estate investor softwareINVESTOR 4 real estate investor software was specially-developed so new investors can learn over thirty formulas for significant rates of return, multipliers, and ratios in real-time right on the forms as the data is entered.

This will give you better command over the nuances of real estate investing and better prepare you to discuss the financial data of investment real estate when you are presented with an investment opportunity. This has proven to be an effective way for any beginner investor to become better informed about investing.

Rates of Return (at a glance)

  • Cap Rate
  • Gross Rent Multiplier
  • Cash on Cash Return
  • Internal Rate of Return
  • Net Present Value
  • Profitability Index
  • Return on Equity
  • Tax Liability (or loss)
  • AND MORE

Reports (at a glance)

Features (at a glance)

  • Unlimited units
  • User-friendly
  • Automatic calculations
  • Integrated name-rider
  • Tax and time value consideration
  • AND MORE

Price and Terms

  • TWO licensed software downloads for two computers!
  • FREE software updates and support for one year!
  • NO subscription or renewal fees!
  • Price: $199.95

System Requirements

  • PC or compatible
  • Windows 98 and later
  • Microsoft Excel 97 or later
  • MAC with MAC Office 4.2 or MAC Office 11

Learn More

You can preview sample reports, screen shots, and purchase INVESTOR 4 real estate investor software by going to real estate investor software

What to Know for Real Estate Investment Decisions Besides Numbers

real estate investmentThe basic calculations that underlie all real estate investments are, of course, the numbers. You certainly will not make a real estate investment decision on any rental property without conducting a full real estate analysis that reveals the cash flows, rates of return, and profitability of any property. This goes without saying.

Nonetheless, there are some other bits of valuable information about the rental property you will need to gather in order to feed the correct data into your real estate analysis and ultimately (hopefully) to help you to make a wise and profitable real estate investment decision.

For this discussion, we will categorize that additional data as “property related” and “market related”. That is, the information that directly concerns the real estate investment property itself, and the information about the local market in which the property is located.

Property-related

Naturally, you will want to know as much as possible about the income and expenses for the rental property you’re considering to purchase. Remember that you’re buying income stream more than a physical property. Only women are beautiful, so in this case you just want to validate the accuracy of the basic income and expense numbers presented to you by the seller or seller’s agent.

1) Review the leases to be sure that they are consistent with the seller’s representation regarding length, tenant options to renew, and at what rates.

2) Check the property tax bill to be sure that the current seller isn’t enjoying some sort of tax abatement that is about to expire or may not apply to you as the new owner. Also consider whether the property will be reassessed following a purchase and how much in property taxes you will pay to own the income property.

3) Look at the utility bills (at least in part) to see whether they match up with what the seller has told you. If you discover discrepancies, ask for an explanation to either satisfy you or cause you to wonder about the seller’s truth and accuracy.

4) Try to obtain the seller’s Schedule E tax return to see whether income and expenses claimed to the IRS line up with what you are being told. Though most sellers are reluctant to show any personal tax information until after there is an accepted offer, ask anyway.

5) Be sure to include language in your offer to purchase the property that makes the seller responsible for providing truthful information and lets you off the hook if you discover otherwise.

Market-related

1) Conduct a comparative market analysis to determine what comparable rental properties have recently sold for. This is typically easier said than done because often there is a lack of enough comparables to be meaningful. Nonetheless, you can get a general feel for your market using a gross rent multiplier, price per unit, and price per square foot for whatever buildings have sold. Any commercial broker worth his salt can do this for you; so you might consider building a relationship.

2) Learn what tenants are willing to pay for space in your market place. In the case of an apartment complex, for instance, what are the monthly rents tenants are paying to occupy various unit configurations? A local property management company can be a great source for this and could be of service to you later so you might want to start interviewing; otherwise you should drive the area and call on the For Rent signs.

3)  Survey what the capitalization rates are for a particular type of property in a particular geographic area. If you don’t know what a capitalization rate (or cap rate) is than by all means do some homework because it is one of the rate-of-return measurements that you will want to know when real estate investing. For your survey, commercial brokers or appraisers are both good resources.

Okay, it’s rather general and might be data more difficult to uncover in some areas than others, but you get the idea.

The fundamental issue is to gather what you can to make your real estate analysis of the property’s bottom line as meaningful as possible. After all, investment decisions should only be made only after the real estate investor knows what’s really going on with any investment property under consideration.

 

Calculator: Latest Inflation Rate Data Added

ProAPOD’s online real estate calculator has recently been updated to reflect the latest US government CPI data released on November 16, 2011 for its inflation rate calculation.

This means that you can calculate the inflation rate and measure the buying power of the dollar between 1913 through to the most current published month for 2011 according to the Consumer Price Index (CPI) published by the Bureau of Labor Statistics (BLS).

Our real estate calculator never charges users for updates, so if you already purchased the calculator you will automatically have access to this updated inflation rate data.

If you are not using this web-based calculator you can learn more at http://www.proapod.com/real_estate_calculator.asp

About ProAPOD Agent 6 Real Estate Agent Software

Real Estate Agent 6ProAPOD AGENT 6 real estate agent software was developed to provide residential real estate agents and others typically less engaged with real estate investing the rock-solid essential elements to soundly get started working with rental income properties.

The software was developed in 2000 primarily because there was no easy and economical way for residential agents who also wanted to service income property to conduct a real estate analysis.

With this popular flagship solution agents can create compelling cash flow analysis and marketing reports for their multifamily property listing and selling presentations or make “on the spot” presentations when the need arises (i.e., investor up-calls and walk-ins).

Origin

AGENT 6 was originally intended for my own investment property business after discovering that other solutions available where certainly not easy to use and far too expensive. Soon thereafter I developed it into a MS Excel application and began marketing because my colleagues also wanted it.

In a Nutshell

AGENT 6 real estate agent software is a complete cash flow analysis and marketing solution that contains all the right elements to service multifamily properties short of tax shelter and time value of money. That is, it computes the cash flows and rates of return on a before taxes basis.

This is perfectly acceptable and has proven to be a highly effective (and economical) way to provide the rock-solid essentials for those who prefer to work with rental properties at a professional “ground floor” level. I personally sold numerous income-producing properties ranging from duplexes to multiple-unit apartment complexes with this software.

Special Features

AGENT 6 calculates both USA (default setting) and Canadian mortgages to accommodate our friends in Canada. The user simply makes the selection right on the form and the program will adjust the loan amortization calculations.

Reports (at a glance)

  • APOD
  • Proforma Income Statement
  • Rent Roll
  • Rent Scenarios
  • Acquisition
  • Marketing Package
  • See the entire list

Features (at a glance)

  • Unlimited units
  • User-friendly
  • Automatic calculations
  • One-click picture function
  • Integrated name-rider
  • See the entire list

Price and Terms

  • TWO licensed software downloads for two computers!
  • FREE software updates and support for one year!
  • NO subscription or renewal fees!
  • Price: $149.95

System Requirements

  • PC or compatible
  • Windows 98 and later
  • Microsoft Excel 97 or later
  • MAC with MAC Office 4.2 or MAC Office 11

Learn More

You can preview sample reports, screen shots, and purchase AGENT 6 real estate agent software by going to http://www.proapod.com/real-estate-agent-software.htm

Oh, the Hypocrisy of Some Real Estate Agents

After thirty years as a real estate professional it seems strange to be surprised about any issue concerning realtors (negative or positive). But having also spent the past ten years as the owner of ProAPOD Real Estate Investment Software I must admit that there have been a few occurrences that smack so loudly of hypocrisy that I must comment.

Understand, however, that I have worked alongside with (and personally know) many brokers and agents, not to mention the fact that the customers for my investment software are primarily realtors. Therefore, as such, I am qualified to suggest that most realtors are pleasant to be around.

Still, not unlike members of any group or industry, there are always going to be a few that get under your skin and cause you to explode. It is these few that I call hypocritical and in turn, must cite as an example.

Earlier this year I was chided by a customer for “daring” to charge a minimal fee to replace software she had purchased three years before and lost to a computer meltdown. Of course I understand computer viruses and the frustration of having to replace software programs, so I lean over backward to acknowledge and accommodate.

In cases when it concerns a customer who made a purchase within the first 12 months, for example, I replace the software at no charge (though I am not obligated to do so). Even with purchases extending beyond 12 months, I am willing to provide a new download of the full working software version for a fraction of the price. This is not unfair, and certainly a lot more generous than the majority of software suppliers that I’ve dealt with.

In this case, she was being hypocritical because she would certainly expect payment for her services. Would she, for instance, ever give back a commission following a transaction merely because the buyer or seller’s situation changes? Has she ever re-sold a property free of charge because her buyers lost their equity to an economic down turns? Of course not, but that’s not a character flaw; no reasonable person would expect her to work for free merely because bad things happen that are out of her control. So why would she fault me, a software provider, for not wanting to work for free?

A second incident occurred recently when I was faulted for posting information about my real estate investment software in a social networking group. The broker considered my information of no value to the membership of real estate professionals. But wait a minute, of course I wouldn’t expect it to have value to all, but my real estate investing software certainly can be of interest to some realtors who service investment property; after all, the software is regularly used by those in the industry.

In this case, I find him hypocritical because I am certain that he posts information regarding properties he has listed for sale that certainly cannot be expected to have value to all in the group. The best he can hope for is that maybe someone might be interested; which is exactly my intent. So why the double standard?

Look, we are all in the same boat; we are in the business of selling–whether it’s property or real estate investing software. We can’t be faulted to charge for our services, and most certainly cannot be blamed for marketing our product; particularly when our product might have value to our real estate colleagues.