Cash Flow Analysis – Real Estate Investing – Part 6 B
This is Part 6 B of my Real Estate Investing Series. You can view the first 5 Parts here:
Are you planning for your Future? Real Estate Investing – Part 1
Starting at Home! Real Estate Investing – Part 2
Maintain Your Leverage! Real Estate Investing – Part 3
Picking Your Investment Property – Real Estate Investing – Part 4
Location * Location * Location – Real Estate Investing – Part 5
Cash Flow Analysis – Real Estate Investing – Part 6 A
Part 6 is Cash Flow Analysis. I have broken this into several parts, Part B will focus on depreciation. You may go to my web site and get a Free Cash Flow Calculator and down load a copy of the live example of this example at the same time.
I believe my example is very conservative and realistic in this market. The numbers are simplified over some other analysis. I will go into some of the reason for the simplifications latter on. This assumes a new home purchased at $200,000.00 with 20% done and a 30 year loan at 6%. I am assuming a monthly rent of $1,800.00.
BASIS:Generally the basis of your investment property will be the purchase price. If you obtain title in some other way it may be different. If inherited it will be the value on the date of death of the person leaving the property. If it is a converted residence it will be the value on the date of conversation. Some Closing Cost can also be added to the basis to be depreciated over the term of depreciation. Check with accountant as to which Closing Cost can be added to the basis. For this excersise I am not adding in any Closing Cost to the Basis. The basis may be adjusted upwards by Capital Improvements.
PROPERTY TAX BASIS: In the first year this may be the same as the Basis, but will change from year to year. The Property Tax Basis has nothing to do with depreciation, I have located it here in the calculator because in many scenarios they will be the same to start with.
DEPRECIABLE PORTION: This is a tricky part. You cannot depreciate the entire property, just the improvements; the land does not depreciate. The portion attributed to improvements will vary. Considerations are land values versus construction cost. This number can be determined by appraisal and sometimes you can use the country assessors break down. I recommend consulting with the accountant on this point as to what the IRS will allow. What ever number you pick is subject to challenge by the IRS.
NET DEPRECIATION PORTION: This is simply the dollar amount figured from the given depreciation percentage. In this example I have used 50%, but it could vary widely.
DEPRECIATION PERIOD: Currently for Residential Rental Property the period of depreciation is set at 27.5 years. Remember if you buy mid year you will only take part of the depreciation in the first year, and probably the last year too. However, before you depreciate out you will probably want to do an exchange. That is a future topic.
ANNUAL DEPRECIATION: Is the dollar amount you are allowed to write off every year. There are some IRS restrictions on Passive Losses. A Passive Loss is paper losses due to depreciation on real estate over and above the income received from the real estate. This is also a future topic.
Depreciation is a powerful tool in Real Estate Investing. When you go to invest you want to find a property that offers as many advantages as possible for you the investor. Try changing some of the flexible numbers a little on the calulator and see how it effects your profits.
Watch this blog for further updates in the series.
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