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Should I determine Cash Flow Before Taxes (CFBT) or Cash Flow After Taxes (CFAT)?

Real estate investors and real estate investment analysts generally look to know the Cash Flow After Tax (CFAT) when evaluating the profitability of investment income properties because it includes tax shelter elements and shows the cash an owner could expect to receive from a property after Uncle Sam takes his cut.

However, even with the popularity among real estate investors and most analysts of knowing cash flow after taxes (CFAT), there are some who simply want to determine the income a property will generate before taxes (i.e. CFBT). ). That seems fine to me. 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 create the cash flow. When you take in more money than you spend (that is, you have money left over after paying all the bills), the cash flow is positive and therefore available for you to take off the table and allocate elsewhere.

On the other hand, if you spend more than you take in, it creates a negative cash flow that requires you to take money out of your own pocket (i.e., out of the property account) to make up the deficiency, thus creating A void that must be filled. without any hope of residential cash.

What is CFBT?

CFBT is an acronym for Cash Flow Before Taxes and essentially means that any cash flow produced by the rental property during a given period of time is calculated before any adjustments 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 less vacancy allowance) of $54,720 with annual operating expenses of $21,888 along with an annual mortgage payment of $24,174, the cash flow per year (before taxes) would be $8,658.

What is CFAT?

CFAT is an acronym for Cash Flow After Tax and essentially means that the cash flows produced by the rental property are calculated after adjusting for taxes and, as such, represent any tax liability the owner encounters as a result of operating the property. property. The calculation is simple: the pre-tax cash flow minus the income tax liability equals the after-tax cash flow.

Before looking at an example, let’s consider what income tax liability is and how it is calculated.

Tax liability is what a real estate investor owes in taxes based on the “taxable income” generated by the property. Revenues less operating expenses (i.e., 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 (i.e., federal and state) to calculate the investor’s income tax liability.

Ok, now let’s consider an example.

Let’s say net operating income is $32,832 along with 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 $963 taxable income by the investor’s marginal tax rate (say 38%) to calculate the owner’s income tax liability (the result is $366). Finally, we subtract that $366 tax liability from the $8,658 pre-tax cash flow 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 investing software and published 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 Reporting, then Pro Forma Income Statement.

Here’s to your success in real estate investing.

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