Cash reserves and taxation

8 Replies

When putting together our first multifamily deal, we built in a cash reserve to be used over a five-year hold for such things like capital improvements and unit upgrades. We don't anticipate using all this money in year one obviously, so my question is whether or not that cash reserve is taxed each year? Thoughts and insight would be greatly appreciated!

Originally posted by @Tyler Henfling :

When putting together our first multifamily deal, we built in a cash reserve to be used over a five-year hold for such things like capital improvements and unit upgrades. We don't anticipate using all this money in year one obviously, so my question is whether or not that cash reserve is taxed each year? Thoughts and insight would be greatly appreciated!

If the cash reserve is your contribution, then no. Meaning if you are setting aside your W-2 ( already taxed) amount for future use, then no. Just like your saved after- tax money in your bank is not taxed each year. 

If you are setting aside a rental income for future capital expenditure, then the cash reserve are taxed as rental income when you earned it. It is not taxed every year.


@Tyler Henfling When you say a cash reserve, do you mean you set aside a portion of the rent each month for repairs and capex? Or you saved up a lump sum to serve as a reserve before purchasing the asset?

You should be reporting all rents received each year regardless of where you're putting that money. It's all taxed. You should also report all your expenses each year to mitigate your tax expense. If you don't already have an accountant with RE experience, go find one. They'll help you save much more than their services cost!

@Tyler Henfling

You can set aside money as a rainy-day fund or to use for repairs/capital expenditures.
Aslong as the money was not earned during the year, it is not taxed during the year.

Depending on how large the amount is, you may receive interest income on this amount. The interest income would be taxable.

What if you reinvest the net income from one property into a second property before year end, resulting in a net loss for the year given the high expenditure of an second down payment?

@Benjamin A Ersing   @Tyler Henfling

Your questions come from the same fundamental mistake when thinking about taxes: combining the source of money and the use of money. The two are completely separate. No such thing as "net loss" between the two for tax purposes.

Source of money is where the money came from, and it controls whether it is taxable as an income. If it came from your savings account - not taxable. If you pulled it out of your non-Roth IRA - taxable. If it was from rents - taxable. If it was proceeds from the sale of a property - partially taxable. Etc.

The use of money, in contrast, controls whether it is deductible as an expense. If it is used as a down payment or rehab of a rental - depreciated. Invested in a syndication - capitalized into basis for future deduction against the sales price. Spent on marketing - deductible. Etc.

Sitting idle and not doing anything - not taxable, except for the interest earned on it if any, and not deductible.

Again, the two sides of money flow, in and out, cannot be combined for tax purposes. Think of them as two separate transactions, and you should have the right tax answer.