The primary purpose real estate investors own income property is to make money; favorably from a steady stream of cash flow generated by the property on a monthly basis as well as a lump sum profit when the property gets sold sometime in the future.
This is the explanation for real estate investing. To buy investment real estate with an "income stream" that regularly generates more rental income than operating expenses and debt service, and to collect sizable proceeds due to the property's appreciation in value upon sale.
Fair enough. But real estate investors consider more than these cash flows and proceeds before taxes. They are also concerned how much they can expect to collect after they pay federal income taxes.
In this article, we'll look at both so you will have an understanding of how they are computed in a real estate analysis.
In essence, both work the same way. The revenue investors collect prior to income taxes is known as the "before tax" (BT) revenue, and the amount of revenue an investor actually can keep after settling up with the IRS is called the "after tax" (AT) revenue.
Cash Flows
Cash flow before tax (CFBT) is rental income less operating expenses less debt service (i.e., the mortgage payment) less any non-funded capital additions.
Rental Income
less Operating Expenses
less Debt Service
less Non-funded Capital Additions
= CFBT
Cash flow after taxes (CFAT) is derived by computing tax liability based upon taxable income and then subtracting that amount from CFBT. Okay, so let's break it down.
Taxable income is net operating income (rental income less operating expenses), less the mortgage interest expense and amortized points, less depreciation. It should also be noted that any interest earned by the investor due to the property's revenue would in turn be added (which we'll ignore for our illustration).
Net Operating Income
less Interest Expense
less Amortized Points
less Depreciation (real property and capital additions)
= Taxable Income
Tax liability is taxable income multiplied by the investor's marginal tax rate (combined federal and state income tax rates). In this case, when the taxable income is a positive amount there would be a tax liability, whereas when it is a negative amount there would be a tax savings. In other words, if income is earned after allowable tax deductions, the investor will have to pay taxes and therefore has a tax liability; if no income is earned, the investor can deduct a loss from his or her income taxes and therefore has a tax savings.
Taxable Income
x Marginal Tax Rate
= Tax Liability (or savings)
The final computation,
CFBT
less Tax Liability
= CFAT
Or,
CFBT
plus Tax Savings
= CFAT
Sales Proceeds
This is the amount the seller can expect to receive once the property is sold.
Sales proceeds before tax virtually represent the dollar amount the seller will collect from escrow at closing. It is the sale price of the property less cost of sale less loan repayment (i.e., balance remaining on the existing loans).
Sale Price
less Cost of Sale
less Loan Repayment
= Sales Proceeds (BT)
Sales proceeds after tax are the sales proceeds before tax less the taxes the investor must pay the IRS due to a sale of the rental income property.
Sale Proceeds (BT)
less Taxes Due to Sale
= Sales Proceeds (AT)
Taxes due to sale is a combination of the recapture tax (or Cost Recovery Recapture) and the capital gains tax less tax savings due to unamortized loan points multiplied by the investor's marginal tax rate.
About the Author
James Kobzeff is the developer of ProAPOD. A leading provider of real estate investor software solutions since 2000. Create cash flow, rates of return, and profitability analysis presentations to evaluate any-size investment opportunity in minutes! Easy and affordable. Learn more at =>www.proapod.com
Article Source: http://EzineArticles.com/expert/James_Kobzeff/35775
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