How to Compute Cash Flow and Sales Proceeds Before and After Taxes

cash flowThe primary purpose real estate investors own income property is to make money; favorably from a steady stream of cash flow generated by the property on a monthly basis as well as a lump sum profit when the property gets sold sometime in the future.

This is the explanation for real estate investing. To buy investment real estate with an “income stream” that regularly generates more rental income than operating expenses and debt service, and to collect sizable proceeds due to the property’s appreciation in value upon sale.

Fair enough. But real estate investors consider more than these cash flows and proceeds before taxes. They are also concerned how much they can expect to collect after they pay federal income taxes.

In this article, we’ll look at both, cash flow before and after taxes and sales proceeds before and after taxes, so you will have an understanding of how they are computed in a real estate analysis.

Cash Flows

In essence, both cash flows work the same way. The revenue investors collect prior to income taxes is known as the “before tax” revenue, and the amount of revenue an investor actually can keep after settling up with the IRS is called the “after tax” revenue.

1. Cash Flow Before Tax

Rental Income
less Operating Expenses
less Debt Service
less Non-funded Capital Additions
= Cash Flow Before Tax (CFBT)

2. Cash Flow After Taxes

CFBT
less Tax Liability
= Cash Flow After Tax CFAT)

Okay, but that doesn’t explain how we arrived at the Tax Liability, so let’s break it down into the appropriate steps.

Step one. Calculate the “taxable income”.

Net Operating Income
less Interest Expense
less Amortized Points
less Depreciation (real property and capital additions)
plus Interest Earned by the Investor (due to the property’s revenue)
= Taxable Income

Step two. Calculate the “tax liability”.

Taxable Income
x Marginal Tax Rate
= Tax Liability (or savings)

Note: When the taxable income is a positive amount there would be a tax liability because income has been earned (therefore a deduction from CFBT). When it is a negative amount there would be a tax savings because it can be deducted as a loss (therefore an addition to CFBT).

CFBT
less Tax Liability
= CFAT

Or,

CFBT
plus Tax Savings
= CFAT

Sales Proceeds

Sales proceeds represent the dollar amount the investor will collect from escrow at closing before payment for income tax.

1. Proceeds Before Tax

Sale Price
less Cost of Sale
less Loan Repayment
= Sales Proceeds Before Tax

2. Proceeds After Tax

This is the dollar amount resulting from a sale after satisfying the IRS for income earned due to the sale of the property.

Sale Proceeds Before Tax
less Taxes Due to Sale
= Sales Proceeds After Tax

Note: “Taxes due to sale” is a combination of the recapture tax (or Cost Recovery Recapture) and the capital gains tax less tax savings due to unamortized loan points multiplied by the investor’s marginal tax rate.

The report provided below illustrates the full computation.