Is cash-flow considered a demerit for tax purposes?

Question

My buyer's agent continually tells me that I should not worry about a positive cash flow to back-calculate an offer. Why? Because you don't want to show income (of cash flow) on your tax return, or else you'll be taxed on it. According to the agent, money on rentals is made in tax deductions, so the investor should focus on that and not worry about 'meager' cash flows.

I'm a newbie :-). Is this wisdom correct? This goes drastically against most of the 'How to evaluate and offer on rentals' webinars posted on BP.

Thanks in advance.

I'm a newbie :-). Is this wisdom correct? This goes drastically against most of the 'How to evaluate and offer on rentals' webinars posted on BP.

Thanks in advance.

Eamonn McElroy · Answer

@Amnaya A.

Your agent has adverse economic interests when dealing with you.  He/she will receive a bigger commission if you can be convinced to lay out more capital for appreciation investments.

Bill Crow · Answer

@Amnaya A.

Your agent should stick to showing properties and stay out of the finances.

Cash flow has nothing to do with taxes.

You can have a cash-flowing property that has a loss for tax purposes, primarily due to the effects of depreciation (a non-cash expense).

If you have a negative cash flowing property, then your only financial benefit as an investor is the gamble on property appreciation.  Some investors are happy with that, but unless that’s your plan, then you need to be fully aware of he potential cash flow of your investment. Otherwise, you’ll be adding funds out of your pocket each month to offset the negative cash flow.

Christopher Smith · Answer

It is inappropriate commentary not only from an economic perspective (which should really come first), but also from a tax perspective. While not likely to be applied in your circumstance, if a person cannot demonstrate that an investment was made with the reasonable possibility of making an economic profit, then the Govt has the authority to fully disallow the tax benefits themselves.

Basit Siddiqi · Answer

@Amnaya A.Your real estate agent is not your financial advisor. You should have an idea of what you are looking for an investment1) Are you looking to invest in a A Class, B Class, C Class or D class Neighborhood2) What is the budget of the home you are looking to purchase3) Do you have a preference in neighborhood4) Are you looking for a SFH or MFH5) EtcThe real estate agent can tell you based on what you are looking for if your budget is reasonable. However, I wouldn't take advice to just spend more money on a house.You lose money/value if it goes wrong while they are out in the clear with their larger commission.

Joe Splitrock · Answer

@Amnaya A. cash flow is not the only measure. It is not uncommon for rental properties to cash flow monthly, but show a loss on taxes at the end of the year. That is mainly because of depreciation and interest.

Also keep in mind that cash flow can be purchased with a larger down payment. Your cash flow increases as your cash into the deal increases. I could pay all cash for a property or 100% finance a property. With all cash I may cash flow $1000 and with 100% financing I may have to pay $50 each month. Which way is better? Many would argue that $0 into a deal is worth $50 out of pocket every month. To get that $1000 cash flow may require $100K or more cash into the deal. You would arguably be better holding your $100K cash and just paying $50 a month or doing multiple deals at 100% financing. Of course this is a fictitious example meant to show the point that cash flow by itself is not the only measure.

However, to say a property should not cash flow implies that the payment/expenses are greater than the rents received. That is normally not advisable, because you are subsidizing the rental every month. It could work if you had a high W2 income or other passive income. It is risky because if you loose the income, you are could be unable to pay your bills on the property.

Feel free to post details of a specific deal and let people comment on it.

Carl Fischer · Answer

@Amnaya A.

Ridiculous-invest to lose money? Nuts! With that thinking you should pay double the price or more.

Andrew B. · Answer

Your agent is either extremely ignorant, or he is a POS who is abusing his fiduciary duty to convince you to buy a house.

Bob Norton · Answer

@Amnaya A. You should fire that agent and find one that understands investment property.  If you quoted your agent correctly, then it appears your agent is violating ethics rules as well as giving advice on a topic they know nothing about (taxes), which by the way opens them up to professional liability.

Your primary decision factor is cash flow, if you are financing the investment property.  Appreciation is icing on the cake. As for taxes, your cash-flowing real estate investment will generate losses in the early years, due to depreciation and mortgage interest write-offs, and it will SAVE you taxes.

Brian D. Beatty · Answer

Your agent may be used to selling homes to Soccer Mom's in Mini-Vans! This does not make sense, for a newbie, you don't have a big portfolio to leverage taxes. Nor should your agent be advising you on it! Their job is to find, analyze, negotiate the deal and get you through the process. Any tax implication should be analyzed by your CPA. Sounds like this agent wants to show as few properties and get their commission!

Michael Plaks · Answer

@Amnaya A.

There're 3 major reasons to invest in real estate:

• cash flow
• appreciation
• tax benefits

#1 and #2 can switch places, depending on your current financial situation and future goals, but taxes is always #3 in importance.

Ideally, you want both cash flow and appreciation. However, it is not wrong to buy properties with minimal or no cash flow - as long as you're mostly after appreciation. For example, if you're financially stable and secure right now, you may focus on appreciation. But it's a complicated case-by-case analysis that should be done with an accountant or a financial planner, as long as they're real estate specialists. Warning: many financial planners will dismiss real estate altogether, because they cannot earn commissions from it, unlike from selling you annuities or mutual funds.

Your Realtor may actually be finding you good properties, as long as your goals are aligned with his. His "wisdom" however is rather unprofessional and uninformed, if quoted correctly.

Is cash-flow considered a demerit for tax purposes?

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