Depreciation accounted for in analysis?

9 Replies

When analyzing cash flow, and with respect to depreciation:

  • Do I calculate depreciation into cash flow projections?
  • If so, is it on the total price, or just the building and not the land?
  • And, is it figured on the basis, or the ARV?

Thank you.

Hi @Dave Smith , depreciation is not a cash expense, so I wouldn't include it in cash flow projections.

Thank you, Logan.  I had seen it on a couple spreadsheets that were designed to analyze cash flow, and it didn't seem right to me.

@Dave Smith So...

1.) Depreciation doesn’t impact cash-flow.
2.) Depreciation can help you on taxes (like mortgage interest). Tax benefits differ between people and relative income.
3.) Depreciation recapture is something you have to take into account if you aren’t a hold-until-you-die-guy.
4.) Dirt (read: land) doesn’t depreciate, “Improvements” depreciate.

Awesome!  Thank you, Andrew.

You can manipulate data to make it tell any story you want.... data doesn't have "right or wrong".

Depreciation is not a cash outlay and as such is irrelevant to cash flow.

Depreciation is based on the "useful life" of a structure. This should be covered by accounting for capex (capital expenditures) which include the new roof, furnace, etc that you will need every X number of years to extend the useful life of the structure.

I know I'm making this harder than it is. For a SFH, or small multis, am I thinking right here:

For Cash Flow:

Gross Scheduled Rents 

- Vacancy at 5% = Effective rental income

+ Other Income = Gross Operating Income

- Operating Expenses = Net Operating Income (NOI)

- Annual Debt Service = Cash flow before taxes

  Add Back:Principal Payments 

  Add back:Depreciation 

Taxable Net Income (or loss)

/12 = Net Monthly Cash Flow 

The "add backs" are throwing me off.

For Cash on Cash:

Cash Flow before taxes 

- Down payment 

- Cost of repairs 

- Closing costs 

- Holding costs 

= Cash on Cash return (CCR)

Thank you.

@Dave Smith It might be easier to think of two separate and unrelated calculations, Cash flow before taxes, and Taxable Income (or loss).  The results of those two are later reconnected to determine your Cash flow after taxes.

Cash flow before taxes =

NOI - Debt service - Capital Expenditures

Taxable Income =

NOI - Interest portion of the Debt service (not principle) - Depreciation

Now that you have those two numbers you can find:

Cash flow after taxes =

Cash flow before taxes - (Taxable Income x Tax bracket)

You are correct for Cash on Cash return = divide CFBT by total cash into the deal (usually down pmt + closing costs + repairs + holding costs)

Very helpful, thank you Derek.

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