Cash Flow After Tax - should analysis consider income tax ?

Question

Hi Everybody

My question is when analyzing a property should I consider income tax in my analysis or should I assume that the deductions will reduce my taxable income to where its pretty much evens out and not worry about it?

I ask because most things I read don't go into that deep into after tax cash flow and I'm interested because to me what is left after you've paid tax is really what I've earned and can be used for investments, paying investors etc.

Let me give an example:

Looking at a property with

NOI - $14,230

Mortgage - $5,012

Capex & maintenance fund - $1943

Cash Flow Before Tax - $7275

Now if I take the taxable income (NOI minus interest on the loan and depreciation over 27.5 years) I now have a CF After tax of $5,387. There should be other deductions that reduce my taxable income but at a minimum I can work these out and have an idea that at a very least I will have $5,387,

I guess my question is, would it be worth figuring out taxable income and CFAT when doing initial analysis on properties or is it safe to just stick with CFBT? Am I making it too complicated?

Thanks!

Dan

Brandon Hall · Answer

@Dan Desler @Justin Fox

Most people will tell you that you don't need to, but they are thinking too small. Otherwise there wouldn't be a market for 1031s, Rehab Tax Credits, and even CPAs like me offering tax planning advice.

You do need to understand your post-tax returns as doing so will give you a true look at your ROI/IRR/NPV of the investment. Then you can compare that number to similar and dissimilar investments and make educated decisions.

I always find it funny that people don't care to determine their post-tax return on a real estate investment, especially since real estate is a tax haven.

Justin - for the average American, one allowance on your W-4 is worth anywhere between $900-1,000. So if you have a $1k refund, increase your allowance by 1.

Hope this helps.

Justin Fox · Answer

I set money aside for income taxes. So if 5,347 of additional income still had you in the 2nd bracket, I would put 67 per month from rents in an account for that purpose. The past two years, it has just gone back into my pocket but I'm slowly finagling my w-4 so I'll break even or even owe a little bit so I'm sure the savings will come in handy one of these years.

I've asked this question too before but have never gotten an answer.

Dan Desler · Answer

Hi All

Thanks for all your responses

@Dave Toelkes to be clear, I only was subtracting Depreciation from NOI (along with interest on the loan) to figure out the taxable income (which I would then apply a tax rate to to figure the approximate tax paid and minus that from my cashflow.

My cashflow is my NOI minus mortgage (P&I), capex etc.

Good point about escrow, thanks for that.

I guess the reason why I'm interested in understanding this far down in the analysis is that I think its a good idea to know at the end of the year approximately what cash you made after all is said and done. For analysis I agree, I can figure out COC return, cap rate & cash flow before tax and see if its a good deal or not, but it seems worth thinking about where you're going to be post tax, so I can have an idea what will be there for reinvestment.

Thanks again

Dan

Dave Toelkes · Answer

Not sure why you would subtract depreciation from NOI. Depreciation does not take any money out of your pocket so it does not reduce your cash flow, but instead, it could increase your after tax cash flow.

One thing that does reduce your cash flow that you have not mentioned is the principal payment on your financing. You have subtracted mortgage interest from NOI, but what about the portion of the debt service that goes to principal reduction? And, if you escrow for taxes and insurance, your monthly escrow contributions over and above whatever you have allocated to insurance and property taxes in your NOI calculation also reduces your cash flow.

Before you get too carried away with this, just ask why you are doing this. Is it to compare two different investments to decide which one to buy? Is it to see if the cash flow is positive or negative? If negative, the after tax cash flow does not seem to matter much if you are not putting any money in your pocket in the first place.

Now in the situation where you are comparing a tax advantaged investment to a taxable investment, then you generally adjust the cash flow from the tax advantaged investment to see what the cash flow would be if you had to pay taxes on the income. Then you compare the before tax incomes from the two investments to see which is better for you.

In the final analysis, if you are trying to decide between two different investments, then it does not matter whether you are comparing before tax or after tax cash flows, just as long as your comparison is "apples to apples".

Justin Fox · Answer

@Brandon Hall

Thanks for the info!

Jonathan Rodriguez · Answer

Good Afternoon,

Personally I think factoring in tax is a great idea. You can even make estimated tax payments to the IRS so you don't have to pay the tax in a lump sum at the end of the year. Here is the form :https://www.irs.gov/pub/irs-pdf/f1040es.pdf

On an initial analysis, maybe, you wouldn't have to as long as there is positive cash flow but taxes are always something we have to deal with so including this factor won't hurt you. Again, I am just offering an opinion.

If you have questions about making estimated tax payments I'd be happy to explain into further detail. I hope this was helpful

Best,

Jonathan Rodriguez

Cash Flow After Tax - should analysis consider income tax ?

Cash Flow After Tax - should analysis consider income tax ?

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