Cash Flow After Taxes | How to Compute For Your Next Real Estate Analysis

When conducting a real estate analysis of investment real estate investors always look for profitability. In other words, they look for the amount of cash flow generated by a rental property in order to make an investment decision as to whether buy or pass on the investment.

In this case, however, it's not merely the cash flow before taxes (CFBT) so much considered by real estate investors (though not ignored), but the cash flows after taxes (CFAT) created by the property. Why, because CFAT is the amount of cash the investor can pocket after the Feds take their cut.

Here’s how it works.

CFBT is the cash produced by an investment property without any consideration for taxes and therefore becomes subject to income tax. CFAT on the other hand is the cash generated by an income-producing property that remains after the investor meets his or her income tax obligation. In other words, one cash amount is collected from the property but subject to the IRS and the other is what the investor can keep after satisfying the IRS.

With that in mind then, let’s consider how to compute cash flow after taxes. You simply take the property’s cash flow before taxes less the investor’s income tax liability.

Cash Flow Before Taxes (CFBT)
less Income Tax Liability
= Cash Flow After Taxes (CFAT)

Okay, but that’s not enough for you to apply the formula effectively to your real estate analysis. So let’s start by breaking it down to the following four key components that make up the formula then show you how it all ties together.

1) The first component is CFBT. As stated, cash flow before taxes is computed by taking the annualized rental income (or more specifically, gross operating income) less operating expenses less debt service.

Gross Scheduled Income
less Vacancy and Credit Loss
= Gross Operating Income
less Operating Expenses
less Debt Service
= Cash Flow Before Taxes (CFBT)

2) The second component is the property’s net operating income (NOI). This is computed by taking the property’s gross operating income (shown above) less operating expenses (no deduction for debt service).

Gross Operating Income
less Operating Expenses
= Net Operating Income (NOI)

3) The third component is the investor’s taxable income or loss which, as the name suggests, is the amount on which the investor must pay Federal income tax. This is computed by deducting from NOI the annual amounts associated with tax shelter. Namely, loan interest paid, depreciation, amortization, and any interest earned by the investor as a result of owning the investment property.

Net Operating Income
less Interest Paid
less Depreciation
less Amortization
plus Interest Earned
= Taxable Income or Loss

4) The fourth component is the investor’s income tax liability which, again as implied, is the amount that the investor must pay in taxes. This is computed by multiplying that amount by the owner’s tax rate.

Taxable Income or Loss
x Tax Rate
= Income Tax Liability

Okay, that brings us back full circle to our primary formula.

Cash Flow Before Taxes (CFBT)
less Income Tax Liability
= Cash Flow After Taxes (CFAT)

But there’s one more thought before we finish.

Bear in mind that in some cases the investor could encounter a taxable income loss as a result of tax shelter; which is than added to (not deducted from) CFBT. For example, say the CFBT is $100,000. Where the investor's tax liability is $30,000 (income gained) the CFAT would be $70,000 (cash flow less tax owed). But where the investor shows a loss of $30,000 the CFAT would be $130,000 (cash flow plus deductible savings).