When a business shows a loss, it’s not a good thing. After all, when a loss is shown it’s because money was lost, right? Not so with real estate.
Rental properties have unique rules that differ from investments in stocks and bonds, and the type of tax deferral that is usually admired in Roth IRAs can seem paltry compared the deferrals rental property owners have available to them.
Rental Property Owners Can Defer Taxes Forever
People who own rental homes can easily operate at a loss. While this is not the main goal for most entrepreneurs, the truth is that with a rental property, a person can appear to lose money on paper while actually taking in a monthly profit.
This is because of depreciation. A rental property might bring in $1,100 every month that covers the monthly mortgage of $975 along with $50 in average maintenance and repairs, netting a profit of $75. But when depreciation is added ((total cost of house plus money invested)/31 years) the yearly cash flow of $900 goes into the red, netting a loss rather than a profit. With that loss comes a deduction.To know the exact numbers you can ask an Realtor in Dallas.
Real Estate Losses Increase Cash Flow
The loss that is shown when taxes are filed brings a larger tax return, and that return is what is known as phantom cash flow.
The phantom cash flow relates to one’s income, or the income of the real estate company formed around the property. Regarding personal income, an investor earning $85,000 annually would fall into the 28% income tax bracket. If this investor purchased the rental home noted above for $155,000 and it needed no updates or repairs, her depreciation would be $5,000.
When the net cash flow is measured against depreciation, the net result on the property will be a $4,100 loss. This “loss” will bring her down into the 25% income tax bracket.
Calculating Phantom Cash Flow
When this investor earned money, she did not receive all of it due to withholdings exacted by the government, such as the 28% income tax rate she appeared to fall into.
In this case, $23,800 was withheld. When it’s found that she suffered this “loss,” her income will be shown as $80,900, meaning that her income tax withholdings are too high. She should have only paid $20,225, bringing her a return of $3,575.
When this phantom cash flow is added to her net monthly cash flow of $75, her little rental property is not only gaining equity from the payments made by her tenants, but it’s providing her with $4,475, or close to $400 every month.
When it comes to investing in rental properties, there are many ways to lose money, but the advantages are just as abundant. The concept of phantom cash flow can be lost on some, but it is a simple idea. A rental home is seen as a depreciable asset just like a car or piece of factory machinery. This depreciation is included as an expense, and while nothing is actually lost, it works to the benefit of the owner.