How to Calculate Cash Flow on Investment Rental Property
Because of government rules and regulations, no realtor or real estate agent will be allowed to forecast or give you any idea about cash flow or ROI when it comes to investment real estate or rental condos. This can leave you frustrated and wanting more information. We can, however, tell you the formula to use so you can get a general idea of your investment possibilities.
If you have not purchased the investment property and are trying to decide the potential returns, you can often find out the rental income from another unit of the same size (if it is a condo) or from neighboring properties. (If it is a home)
What is your taxable income or loss from the investment property?
Taxable Income or loss is the amount of your rental income, less operating expenses, depreciation on the property, and mortgage interest costs.
Depreciation can only be figured on the cost of the building. So with a house, you will need to separate the land cost from the building cost to do this. Depreciation is spread over 27.5 years, and not paid out in cash each year. Divide the cost of your building by 27.5 years, and that is your depreciation expense.
Figure your Interest Expense for the year on the mortgage and any borrowed funds used to purchase the property.
Operating expenses would include property taxes, condo insurance, repairs or losses from maintenance problems, and any charges from rental management companies and cleaning costs. One thing to think of- On site rental management usually charges around 50% or one-half of your rental income. Outside services for condo rentals in Myrtle Beach, such as Condolux, charge around 25-30%. Big difference!
Find your projected rental income if possible, or if you’ve already passed your first year, use the rental income figures. Subtract the Depreciation, Interest Expense, and Operating Expenses from this amount, and the result is your CASH FLOW for this real estate investment property.
If you have a LOSS, and if you’re not a real estate professional, here’s how your rental loss could affect your income tax, as of present 2005 tax laws.
If you actively manage the investment real estate and your adjusted gross income does not exceed $100,000, the rental loss (up to a maximum of $25,000) could be deducted from other income such as salary, interest, and dividends. Multiply the rental loss by your federal income tax rate. You will now have avoided a certain amount of income tax, and this can be figured into the cash flow.
New Cash Flow Calculating Process:
Plus: Tax savings
Less: Operating expense
Less: Mortgage payments
Equals= CASH FLOW
Assuming the investment real estate now just about “breaks even” on cash flow, your equity in the property increases each year as the mortgage loan is paid down. Any increase in the value of the property during the years of ownership will increase the owner’s ultimate return.
Calculating the cash flow on a real estate rental property investment you’re considering will help you decide whether the investment is a good one. You may want to avoid investments with a negative cash flow unless you can come up with additional money to cover operating costs and debt payments.
What is 1031 Tax Exchange, and how can it help me?
We want to help make your investment real estate transactions as economical and as efficient
as possible. That’s why we believe that the “tax deferred exchange” is an approach that should be considered by anyone who owns investment or business related property.
Learn how a 1031 Tax Exchange works, or contact us for more information.
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Original Content By SMITH LIVING...™
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