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.

Aiola CPA, PLLC

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Sean Julian
Rental Property Investor · Porter, TX · Member since 2020 · 93 posts · 42 votes
6y
Do we need a CPA in the state we invest or can my local CPA take care of me legally?
1 Reply
Max T.
Investor · Philadelphia, PA · Member since 2015 · 3k+ posts · 3k+ votes
6y
@Ricardo A Perez
No, taxation is theft
0 Reply
Brian G.
Rental Property Investor · Los Angeles, CA · Member since 2013 · 1k+ posts · 1k+ votes
6y
@Sean Julian ask your CPA if they can help you. Mine is OOS and it’s no problem.
0 Reply
Sean Julian
Rental Property Investor · Porter, TX · Member since 2020 · 93 posts · 42 votes
6y
@Brian Gerlach ok thanks!
0 Reply
Daniel Taylor
West Chester, PA · Member since 2018 · 24 posts · 10 votes
6y
@Brian Gerlach
Thanks for using an example with hard numbers. I feel like you just turned on a light in my mind!
0 Reply
Jeremy Blevins
Folsom, CA · Member since 2018 · 134 posts · 100 votes
6y
@Joe Martella reading this book right now!
0 Reply
Todd Ashley
Rental Property Investor · Portland, OR · Member since 2015 · 96 posts · 23 votes
6y
How does all of this play into DTI? If you are claiming deductions such as depreciation doesn't that substantially decrease your income for qualification purposes?
0 Reply
Derrick Dill
Investor · Hawaiian Gardens, CA · Member since 2015 · 308 posts · 386 votes
6y
^DTI is debt to income ratio. Depreciation is not a debt, and it is not an income. It is a tax deduction.
Ex. If I have 1000$ in monthly debts/loans/credit cards and 4000$ in income my DTI is 25%. At the end of the year, when I input depreciation into my taxes, is that 1000$ monthly debt/loan/CC higher/lower? is my 4000$ in income higher/lower? Since they are unaffected, DTI is unaffected.
If you want to change your DTI, lower your debt (by paying off your loans/CC) or increase your income.
Tax deductions don't affect DTI
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Brian G.
Rental Property Investor · Los Angeles, CA · Member since 2013 · 1k+ posts · 1k+ votes
6y
@Daniel Taylor no problem. Once you file your first schedule E on a property it will be forever cemented in your mind!
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Todd Ashley
Rental Property Investor · Portland, OR · Member since 2015 · 96 posts · 23 votes
6y
@Derrick Dill Thanks! What about deductions related to maintenance, improvements, etc.? Ex. The property grosses $20,0000 in a year, but a new roof and furnace were installed... I'm assuming those expenses count against the gross similar to PITI?
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Derrick Dill
Investor · Hawaiian Gardens, CA · Member since 2015 · 308 posts · 386 votes
6y
For rental property, those expenses count against the that 20,000$
0 Reply
Will Dixon
Accountant · Corte Madera, CA · Member since 2018 · 73 posts · 88 votes
6y
@Todd Ashley
I can't say this is the case for all underwriters, but for my current refi, insurance, interest, taxes, and depreciation were all added back to the property's net income to determine the usable income for the DTI calculation. So some deductions have an impact, but depreciation is not one of them.
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Todd Ashley
Rental Property Investor · Portland, OR · Member since 2015 · 96 posts · 23 votes
6y
@Will Dixon
Thanks for sharing! Very Interesting. So was the total cost of those items added back to your income or just the resulting tax savings?
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Ricardo A Perez
OP
Hollywood Florida · Member since 2019 · 90 posts · 46 votes
6y
Wow.. so glad for everyone’s response sorry I could not respond to all. But so thankful I can start a great discussion !!!!!
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Joe SplitrockPro Member
Moderator
Rental Property Investor · Sioux Falls, SD · Member since 2015 · 9k+ posts · 18k+ votes
6y
@Ricardo A Perez one important thing to realize is "tax profit" and "cash flow" are two completely different things. You may have cash flow every month and have a tax loss at the end of the year. You could also have negative cash flow every month, yet have a tax profit at the end of the year.
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Ricardo A Perez
OP
Hollywood Florida · Member since 2019 · 90 posts · 46 votes
6y

@Joe Splitrock love that explanation positive cash flow but taxes loss at the end of the year.
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Tony Kim
Rental Property Investor · Los Angeles · Member since 2018 · 844 posts · 1k+ votes
6y
Originally posted by @Derrick Dill:
For rental property, those expenses count against the that 20,000$

@Todd Ashley, While technically true, your original question asked about maintenance and improvements. Maintenance items do count directly against the 20,000 and so you would offset the entire amount in a single tax year. However, for improvement items such as replacing the entire roof, unless we are talking about a non-residential commercial property, this expense should be capitalized and depreciated per the IRS determined useful life. I believe a roof is 27.5 years. So yes, replacing an entire roof does count against your annual gross income, but it would do so gradually.
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Will Dixon
Accountant · Corte Madera, CA · Member since 2018 · 73 posts · 88 votes
6y
@Todd Ashley
Total cost was added back to income.
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Todd Ashley
Rental Property Investor · Portland, OR · Member since 2015 · 96 posts · 23 votes
6y
@Tony Kim @Will Dixon
Thank you both for your input! I have never full grasped how costs/deductions associated with rental properties impact how income is counted for DTI purposes. Are there certain deductions that you consider not taking advantage of because you don't want it to impact your DTI?
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Will Dixon
Accountant · Corte Madera, CA · Member since 2018 · 73 posts · 88 votes
6y
@Todd Ashley
That really depends on the circumstances. I have some substantial loss carryforwards and at the current rate it will take me a few years to exhaust them. While going through underwriting I did reconsider taking my mileage deduction, although it was not very impactful in terms of DTI. Choosing to capitalize items that you would normally expense for being under the $2,500 de minimis safe harbor is one way to reduce your deductions in a given year.
Your tax return should also be truthful. So it would be ill advised to not report certain expenses for the sole purpose of meeting underwriting requirements. The underwriting rules are there as a protection for both the lender and the borrower. If you are looking to refinance in the next 12 months, then you may want to mention that to your CPA come tax time.
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Nitin John AbrahamPro Member
Rental Property Investor · Oakland, CA · Member since 2019 · 80 posts · 22 votes
6y
@Ricardo A Perez you can also depreciate property using cost segregation for the property. That allows you to depreciate the home and it's elements at different rates.
My experience is that this is benifical only if your homes are 100k or more in value.
1 Reply
Dave Toelkes
Investor · Pawleys Island, SC · Member since 2008 · 1k+ posts · 837 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.

While this may be the case for the majority of rental property owners, it is not exactly accurate. There are scenarios in which some or all of the depreciation taken (or that should have been taken) is not taxable. It would be more accurate to say depreciation that did not occur is recaptured at the time of sale.

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