First, let’s get the loan payments correct. A $100K amortizing loan at 7% interest for ten years has a monthly payment of $1,161.08. In the first year, you will have made 12 loan payments totalling $13,933.02. Of this amount, $6,773.18 will be interest, the rest is applied to the loan balance. Note that 7% of $100K is $7000, not $700. Because we have an amortizing loan, the interest paid each month goes down as the loan balance is reduced.

The $7,159.83 used to pay off your loan is not a tax deduction. The money you borrow is not taxed to you as income, so the money you pay back is not a deductible expense on your tax return.

Let’s say that your annual loan payments ($13,933.02), your property taxes ($1016.98), and your annual hazard insurance premium ($650) all total $15,600. Your property was rented for the entire year at $1300 per month. At the end of the year, you collected $15,600 in rental income. Your income covers your outflow, so you break even.

For tax purposes, however, your rental income is only offset by $8440.17 because the loan principal you repaid is not an allowed expense. It may appear that you have a taxable net rental income of $7,159.83, but you have not taken your depreciation expense. When you work the numbers, you find that you have an allowable depreciation expense of $2909.09.

On your tax return you will show a net passive income of $4250.74 even though you really broke even on a cash flow basis before taxes. In the 25% tax bracket, your taxable rental income will add $1063 to your total tax liability. in this instance, you will have to come out of pocket $1063 to pay your taxes.

In this example, we have a net taxable income from rental operations because we used a 10 year loan term. Using a 30 year term reduces your monthly loan payment to $665.30, or a total of $7983.63 the first year. Now when your principal, interest, taxes and insurance equal your total rental income, you will have only $1015.81 in non-deductible principal payments. Adding in the depreciation expense of $2909.09 gives you a net passive loss of $1893.28 even though you broke even on a cash flow basis before taxes. In the 25% tax bracket, your net passive loss will reduce your total tax bill by $473.32.

Does this clear it up for you?