Do you pay taxes on cash flow ????

Hollywood Florida · Member since 2019 · 90 posts · 46 votes

Hey BP family ! Any CPA’s out there lol . I am a new investor and I have been taught the formula goes like this Income-expenses = cashflow but, my question is do you pay taxes on that “cashflow” ? If so, how much should I be setting a side to pay on taxes. Thank you in advise for responding !

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Nicholas AiolaBusiness Member

CPA & Investor · New York, NY · Member since 2017 · 1k+ posts · 1k+ votes

@Ricardo A Perez I'll try to consolidate some of the responses...

You do NOT pay tax on cash flow; you pay tax on taxable income. Cash flow almost never equals taxable income. The main contributor to this difference is depreciation. Depreciation expense is a non-cash deduction that reduces taxable income but does not reduce your cash flow.

Residential real estate is depreciated over 27.5 years but it's much more complicated than taking the purchase price and dividing by 27.5. You have to factor in closing costs, break out the portion allocated to land since land is not depreciable, separate the loan costs and amortize them over the life of the loan, etc.

If the property is sold (absent a 1031 exchange), you will have to recapture the depreciation up to the amount you benefitted from the depreciation deductions while you held the property. This is called Unrecaptured Sec. 1250 Gain. This gain exists whether or not you actually deduct depreciation expense, so it's extremely important to calculate basis correctly, deduct depreciation each year, and calculate the unrecaptured Sec. 1250 gain correctly in the year of sale.

It can get complicated quickly but if you plan to DIY it, make sure your verify your source information.

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Derrick Dill
Investor · Hawaiian Gardens, CA · Member since 2015 · 308 posts · 386 votes
6y
Short answer to your question, yes. All cash flow income will be added to your total income and be taxed at your income tax rate.
However, you deduct several things from your taxes from rental properties: Mortgage interest, property taxes, management fees, repairs, basically any expense that goes into your rental is tax deductible.
8 Reply
Victor N.
Investor · Wellington, KS · Member since 2016 · 256 posts · 188 votes
6y
@Ricardo A Perez. No, you don't pay taxes on cash flow. You pay income taxes on net taxable income. The principal portion of mortgage payments are not deductible and are made with taxable income. Cash flow is reduced by deductible expenses including noncash expenses like depreciation. Many rentals have positive cash flow and a tax loss due to depreciation.
7 Reply
Eric James
Investor · Malakoff, TX · Member since 2017 · 2k+ posts · 2k+ votes
6y
Another import little tidbit.....if you sell a property you have to pay tax on all the deprecation you have taken to that point.
5 Reply
Corey YoungPro Member
New to Real Estate · Tyler, TX · Member since 2019 · 41 posts · 30 votes
6y
@Eric James
Unless it’s a 1031 exchange, right?
8 Reply
Ricardo A Perez
OP
Hollywood Florida · Member since 2019 · 90 posts · 46 votes
6y
@Derrick Dill thank you so much for that explanation. Now I understand why everyone keeps saying make sure you get a CPA.
0 Reply
Ricardo A Perez
OP
Hollywood Florida · Member since 2019 · 90 posts · 46 votes
6y
@ Victor N thank you so much for the explanation. Just like I expressed to @Derrick Dill now I get way it is important to get a CPA on your team. Thank you guys ! For breaking that down.

0 Reply
Chris Mackinlay
Midland, TX · Member since 2015 · 90 posts · 75 votes
6y
@Eric James
I did not know that.
Thank you.
0 Reply
Ricardo A Perez
OP
Hollywood Florida · Member since 2019 · 90 posts · 46 votes
6y

@Eric James thank you that gem ! I did not know that.

0 Reply
Brian G.
Rental Property Investor · Los Angeles, CA · Member since 2013 · 1k+ posts · 1k+ votes
6y
@Ricardo A Perez income from rentals are tax efficient though since you do not pay fica taxes (social security/medicare) on the income and as others have pointed out you get to claim depreciation on the asset as a deduction lowering your tax liability.
1 Reply
Ricardo A Perez
OP
Hollywood Florida · Member since 2019 · 90 posts · 46 votes
6y

@Brian G. just want make sure I am on the same page as you guys the depreciation you guys are mentioning. I was reading in a book that the IRS allow you write off 27.5 years of useful life as the depreciation period. Is that the depreciation formula CPA’s use ?

2 Reply
Nicholas AiolaBusiness Member
CPA & Investor · New York, NY · Member since 2017 · 1k+ posts · 1k+ votes
6y
@Ricardo A Perez I'll try to consolidate some of the responses...
You do NOT pay tax on cash flow; you pay tax on taxable income. Cash flow almost never equals taxable income. The main contributor to this difference is depreciation. Depreciation expense is a non-cash deduction that reduces taxable income but does not reduce your cash flow.
Residential real estate is depreciated over 27.5 years but it's much more complicated than taking the purchase price and dividing by 27.5. You have to factor in closing costs, break out the portion allocated to land since land is not depreciable, separate the loan costs and amortize them over the life of the loan, etc.
If the property is sold (absent a 1031 exchange), you will have to recapture the depreciation up to the amount you benefitted from the depreciation deductions while you held the property. This is called Unrecaptured Sec. 1250 Gain. This gain exists whether or not you actually deduct depreciation expense, so it's extremely important to calculate basis correctly, deduct depreciation each year, and calculate the unrecaptured Sec. 1250 gain correctly in the year of sale.
It can get complicated quickly but if you plan to DIY it, make sure your verify your source information.
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12 Reply
Ricardo A Perez
OP
Hollywood Florida · Member since 2019 · 90 posts · 46 votes
6y
@Nicholas Aiola thank you for consolidating all the responses and providing me that explanation. I can see how complex it can get. I will not be doing it DYI. I am planning on leaving it to the professional as your self. I plan to invest in Massachusetts in 2021. Do you do take on clients in Massachusetts?
0 Reply
Joe Martella
Rental Property Investor · Cherry Hill, NJ · Member since 2015 · 626 posts · 495 votes
6y
Don’t forget your mileage. I use mile logger. IT allows me to track every time I take a trip for my rental properties (Lowe’s, Home Depot, etc...) and it puts it into a spreadsheet so you can hand to your accountant.
I think you should read the book by Tom Wheelwright - taxfree wealth. It will help you understand a little better.
3 Reply
Pat L.
Rental Property Investor · Upstate, NY · Member since 2012 · 3k+ posts · 3k+ votes
6y
Originally posted by @Eric James:
Another import little tidbit.....if you sell a property you have to pay tax on all the deprecation you have taken to that point.

Agreed, my wife just re-did the Tax Return for an investor & he got $21,000 back. This was the first time he has taken depreciation, but still insists on doing his own (Turbo) tax return.

We had another investor friend looking to refi to payoff his HM's. They denied it because he had never shown any income on the properties??? All of a sudden they are NOW cash cows!!!
3 Reply
Moises R Cosme
Flipper/Rehabber · Leominster, MA · Member since 2020 · 667 posts · 384 votes
6y
@Derrick Dill has the right answer. I would add that BEFORE you start investing you should determine what entity you will use for the investing, Michael Lantrip has an excellent book on this - cheap and very simple to read through. If you use a corporation as the investment vehicle you can pay yourself to manage the property and the corp can expense your pay. You will owe taxes on profits in the corp if you go this route and there are expenses associated with having the corp, but it is an alternate way to look at things. I hope this helps!!!
3 Reply
Eric James
Investor · Malakoff, TX · Member since 2017 · 2k+ posts · 2k+ votes
6y
Originally posted by @Corey Young:
@Eric James
Unless it’s a 1031 exchange, right?

Right. The other way to avoid paying deprecation recapture is to die, lol. Your heirs get a new deprecation basis and can sell without having to pay deprecation recapture.
4 Reply
Chinmay N.
Investor · Jersey City, NJ · Member since 2020 · 39 posts · 22 votes
6y
@Nicholas Aiola Thanks for summarizing it so clearly. I'm curious if the taxable income in this case is just the cash flow (rent - expenses) or the whole rent before deducting expenses? I thought the whole rent rec'd. from the tenant would be considered as your taxable income here. Is that incorrect?
0 Reply
Chinmay N.
Investor · Jersey City, NJ · Member since 2020 · 39 posts · 22 votes
6y
@Joe Martella that's interesting. What all do you get to deduct with milage on your taxes? Just gas and car expenses or the value of your time too?
0 Reply
Joe Martella
Rental Property Investor · Cherry Hill, NJ · Member since 2015 · 626 posts · 495 votes
6y
@Chinmay Nerurkar you get the mileage rate deduction, plus repairs/maintenance and whatever else my accountant does with the information.
1 Reply
Chris SeveneyBusiness Member
Moderator
Investor · VA · Member since 2015 · 21k+ posts · 19k+ votes
6y
@Ricardo A Perez
Cash flow on what ? Cash flow on a rental may be treated differently than cash flow on a note.
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Syed H.
Developer · NY/NJ/PA · Member since 2018 · 758 posts · 935 votes
6y
You pay tax on any income after depreciation, not cash flow. Depreciation recapture is a tax if you sell. It doesn’t recollect the full depreciation. Depreciation is one of the biggest gives to REIs.
2 Reply
Ricardo A Perez
OP
Hollywood Florida · Member since 2019 · 90 posts · 46 votes
6y
@Chris Seveney sorry I was clear yes, I meant rental income.
0 Reply
Ricardo A Perez
OP
Hollywood Florida · Member since 2019 · 90 posts · 46 votes
6y

@Chris Seveney I meant to write not clear.
0 Reply
Nicholas AiolaBusiness Member
CPA & Investor · New York, NY · Member since 2017 · 1k+ posts · 1k+ votes
6y
@Chinmay N. taxable income is gross rental income less expenses, including non-cash expenses like depreciation and mileage.
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Brian G.
Rental Property Investor · Los Angeles, CA · Member since 2013 · 1k+ posts · 1k+ votes
6y
@Ricardo A Perez yes, you get to write off the value of the structure (ie not the land) which is a % of your purchase price. So if by example you buy a $100k property and city assessor says land is worth $25k and structure worth $75k (city assessors office usually has a calculation they use to figure out your property tax) then you can write off $75 over 27.5 years on a residential property. So $75k divided by 27.5 = $2,727. So if you made $5,727 in profit after all expenses you would then subtract your depreciation of $2,727 and only pay taxes on $3,000 (ie $5,727-$$2,727 = $3,000). Hope that is clear.
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