Income tax when assessing deals?

Question

When initially assessing a deal, how should I account for income tax on the rental income? Without an accurate number for write-offs I'm having trouble putting any faith in my calculated ROIs.

Thanks!

Account Closed · Answer

Thanks Macks that's exactly what I was looking for. Much appreciated.

Mack Benson · Answer

What I was told when I was starting out looking for SFR's is that you shouldn't worry about income tax because your deductions will just about or totally wipe out your liability. If you want a professional's opinion I would consult with a CPA.

If you want an amateur's take I can offer what I do. I know that in my area my effective tax rate between the federal and state income tax is going to land between 30% and 35% of my income. The simplest thing to do is take your cash-flow after expenses but before debt service and multiply it by your effective tax rate, that will give you an estimate on the taxes you will owe. It's a pretty dirty number because it doesn't include the interest deduction or depreciation.

To calculate depreciation, and assuming you are not cost segregating, you need to know the value of the property at purchase (your purchase price,) but you would need to have a separate value for the improvements and the land because land does not depreciate. Take the value of the improvements and divide by 27.5. You can take this depreciation value and subtract it from your estimated taxes to give you your new income tax amount. Most likely this number will be in the negative range so it could wipe out other income you have from a W2 or other income source.