Cash on Cash Returns with Taxable Equivalent Adjustment

[Kevin Chin]

Hey BP,

I've been researching and searching intensely for the past month or so. I'll bold my key questions.

My question is Cash on Cash Returns and comparing them to other forms of investment.  When I am looking at real estate,  I view the cash flow as an alternative to fixed income preferred stock which provides say 5% in annual yield before taxes.

When I am comparing it to Cash on Cash returns, I feel that the straight calculation doesn't adjust for the tax benefit of the return.

I hope to understand this correctly, the cash on cash return is before we apply depreciation for tax purposes so wouldn't the cash on cash need to be adjusted for a taxable equivalent yield?

If you're net income before depreciation is $2,500 on a $200k property, assuming 27.5 yr straight line depreciation, your depreciation expense would be ~$7k, so you're reporting $0 in taxable income.  So if an investor is targeting a 5% Cash on Cash return for a house with say a 30% tax bracket, the taxable equivalent yield would be 7.14%? Just using basic math for simplicity.

Would you be carrying the credit of the difference of the loss ($4,500/year) towards your capital gains base when you eventually sell it down the road?

I'm trying to make sure I'm understanding this correctly and trying to see if my threshold to invest should be lower once you factor the tax advantages of real estate.

I would welcome any feedback or poking holes.  Hopefully I wrote this logically and not too confusing but I've been confusing myself. Thanks everyone!