Should I determine cash flow before tax (CFBT) or cash flow after tax (CFAT)?
Real estate investors and real estate investment analysts generally seek to know the cash flow after tax (CFAT) when evaluating the profitability of investment income properties because it includes the elements of tax protection and shows the cash that an owner could expect to receive. of a property later. Uncle Sam takes his share.
However, even with the popularity among real estate investors and most analysts for knowing the cash flow after tax (CFAT), there are some who simply want to determine the income that a property will generate before taxes (i.e. CFBT ). Fair enough. So what is the difference?
What is cash flow?
This is the flow of funds that results from the inflow and outflow of money. In other words, all the income generated by the investment property minus all the expenses to maintain the property creates the cash flow. When you receive more money than you spend (that is, there is money left after paying all the bills), the cash flow is positive and therefore available for you to remove from the table and assign elsewhere.
On the other hand, if you spend more than you receive, a negative cash flow is generated that requires you to take money out of your own pocket (that is, out of the property account) to make up the deficiency, so it is created a void that you must fill. with no hope of residential cash.
What is CFBT?
CFBT is an acronym for Cash Flow Before Tax and essentially means that any cash flow produced by the rental property over a given period of time is calculated before any adjustment for taxes and therefore does not take into account the impact of the property on the owner’s income tax. responsibility. For example, if a rental property generates an annual income stream (that is, rental income minus vacancy allowance) of $ 54,720 with annual operating expenses of $ 21,888 along with an annual mortgage payment of $ 24,174, the flow of Annual cash (before taxes) would be $ 8,658.
What is CFAT?
CFAT is an acronym for Cash Flow After Tax and essentially means that any cash flow produced by the rental property is calculated after adjusting for taxes and as such represents any tax liability the owner encounters as a result of the transaction. of the property. The calculation is straightforward: pre-tax cash flow minus income tax liability equals after-tax cash flow.
Before looking at an example, let’s consider what income tax is and how it is calculated.
The tax liability is what a real estate investor owes in taxes based on the “taxable income” generated by the property. Income minus operating expenses (that is, net operating income) less deductions for depreciation, mortgage interest, and loan points calculate taxable income which is then multiplied by the investor’s marginal income tax rate (ie i.e. federal and state) to calculate the investor liability income tax.
Okay, now let’s consider an example.
Assume that net operating income is $ 32,832 along with an annual interest expense of $ 20,048, amortized loan points of $ 112, and a depreciation (or cost recovery) allowance of $ 11,710.
First, we calculate taxable income by subtracting those amounts from net operating income (the result is $ 963). Second, we multiply that taxable income of $ 963 by the investor’s marginal tax rate (say 38%) to calculate the owner’s tax liability (the result is $ 366). Finally, we subtract that tax liability of $ 366 from the pre-tax cash flow of $ 8,658 that we calculated earlier to determine the after-tax cash flow (the result is $ 8,292).
All of this is automatically calculated by my real estate investment software and posted on the Proforma Income Statement (which is also created automatically). You can view a sample on my website at http://www.proapod.com by clicking Executive 10.0, then Reports, and then Proforma Income Statement.
For the success of your real estate investment.
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