Is Cash Flow Taxed and as What?

Question

Might be a stupid question but - is Cash Flow Taxed? I've heard some people say that cash flow goes "straight to your pocket and it's all yours" and others say don't forget you pay taxes on it. Well, which one is it? If it is taxed, and I live in California but invest out of state, am I taxed as income in California?

Thanks all.

Matthew Paul · Answer

This is The United States of America , no money goes straight in your pocket without getting taxed . And you live in California , they tax you to breathe the air .

Jordan Decuir · Answer

@Jonathan Shnoravorian

Yep. It is taxed but the depreciation will, in many cases, cause an SFR to show a loss on paper, per the IRS’ rules. In this case, there would be tax on the cash flow. This is likely what those folks are referring to when they say the cash flow isn’t taxed.

Joe Splitrock · Answer

@Jonathan Shnoravorian all income is taxed. @Kevin McMaster refinance money is debt, not income. It is also worth noting that interest from cash out refinance money is only deductible if it is used for investment purposes. If I refinanced a rental property, took out $50,000 and bought a boat, I would not be able to expense the interest on that $50,000. So if the total loan was $100,000 then I would claim only half the interest.

Cash flow is income after all expenses including debt service. The principal portion of a mortgage payment is not considered an expense. Only the interest portion and taxes/insurance (if they are escrowed) are considered expenses.

What that means for tax purposes is you are reporting all income (all rents) as your gross income, not just cash flow. You deduct all expenses, including mortgage interest, taxes, insurance, etc. The value of the structure (and other capital expenditures) are expensed using a process known as depreciation. This takes the value of the property and allows you to claim it as an expense over 27.5 years for residential. Depreciation is a considerable expense and it prevents you from paying taxes on most of your rental income. Be aware that depreciation is recaptured at the time of sale, meaning you pay taxes on it in the future so it is "free today, pay tomorrow".

It is possible to have a situation where there is no cash flow, but there is taxable income. That is because taxes are not directly tied to cash flow. Generally speaking, the expense of depreciation, combined with interest and other expenses will reduce your taxable income considerably on a rental property. Your resulting taxable income could be more or less than your actual income through cash flow.

I would be careful to make sure you set aside money for taxes. If the income is considerable, you are required by law to submit quarterly payments to the IRS. If you fail to submit payments and end up with a large tax bill, the IRS will charge you interest. This probably isn't a concern with one property, but as you grow your portfolio, it is something to plan for.

What I am talking here is Federal taxes, but California will also likely get their share.

Talk to your tax advisor and they can determine the best action plan. I would not DIY this, because of the complexities of depreciation and knowing what is or is not an expense.

Jordan Decuir · Answer

@Irasa Downing

First let me say that I am in no way a tax expert...I generally despise all taxes in any form lol. But, the reserves that you set aside for future CAPEX and/or maintenance/repair expenses cannot be deducted from the property’s cash flow. Once those funds are actually expended, then they will be a deduction from the property’s cash flow.

Derrick Dill · Answer

It's taxed as income. ex. you made 100k in w-2 income. You NET 10k from your rental property. You're taxed on 110k.

Is there more involvement in your taxes  that makes it not so simple? Yes, like depreciation, interest, repairs, etc.

Kevin McMaster · Answer

@Matthew Paul

Refi money is pretty close to free....

Basit Siddiqi · Answer

Rental income = Cash flow + principal payments - depreciation.

Darius Ogloza · Answer

For as crash course in learning how to calculate net income take a look at Schedule E to the Federal form 1040.  It will teach you a lot.

Irasa Downing · Answer

@Jordan Decuir is it taxed as ordinary income? What about the amount you take out for cap ex, vacancy’s etc... or is it inclusive strictly net profit after debt service?

Is Cash Flow Taxed and as What?

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