Hello
I’m having a hard time calculating cash flow. I’m from NY and Im currently shopping for 2 family homes. When doing my math to see if it’s going to be a deal, I have a question on when to take out the tax liability. Do I charge 20% (I know % will vary on which tax bracket I’m in) on the actual rents I receive every month before subtracting my expenses (If I get $1500 a month, I subtract $300 for taxes and start subtracting my other expenses) or do I calculate taxes owed after what’s left from subtracting all my expenses ($1500 minus vacancy lose/variable & fixed expenses / reserves / debt payment, now I’m left with 500, minus 100 for taxes and that leaves me 400 in my pocket)

I would recommend that you ignore income taxes when figuring cash flow. When figuring cash flow, subtract all expenses except income taxes from your rents, including PITI (Principal, interest, real estate taxes and insurance), allowance for repairs, and allowance for vacancies. Income taxes are only important if you have a profit.

Wilson,
You say Income taxes are only important if you have a profit. I think I would have a profit every year. Let’s say after all expenses are paid for except income tax, I have $500 per month. Isn’t that a $6000 profit?

My fear is buying a house and then finding out that I’m only making $100 per month. To me, that’s not worth it. This question comes up because while shopping for 2fam’s, I had a RE investor friend of mine take a look at the numbers on one of the properties. He said everything was fine except for the income tax. He said I need to tax the total amount of what I receive, not what’s left over after expenses. Now I was short $400 and the deal was no longer a deal. But then I was told/taught to calculate taxes once I have my NOI minus debt service.

Sorry if I’m making this more complicated then what it is. I just don’t want to get in over my head on my first investment

You really need to download the spreadsheet I mentioned earlier. The spreadsheet correctly projects your taxable income. The spreadsheet will estimate both your pre-tax and your after-tax cash flow.

Essentially, taxable income starts with your NOI. Then subtract your mortgage interest (wrong to use debt service), then subtract your depreciation expense. If you still have a positive number, that is your taxable income. If you have a negative number, that is your passive loss.

Dave
Thanks for the link. But after looking over the spread sheet it was a little too much for me to understand. I have a spreadsheet that works almost the same way but made it easier for me to understand. In order to have it 100% I need to know when the tax income is applied. I would be more then happy to share it with you if interested.

You pay taxes on your net rental income once a year when you file your 1040. Your friend gave you misleading information when you were told that you pay taxes on your gross income.

Also, there is no 20% ordinary income tax rate. Whatever tax bracket you are in dictates the tax rate applied to your net rental income. That is why the spreadsheet you downloaded asked what tax bracket you are in.

The capital gains rate and the depreciation recapture rate only apply when the property is sold.