How do you know if a rental property is potentially a good investment?
One important metric is its annualized rate-of-return (ROR), sometimes called return-on-investment (ROI).
How do you know an investment property's ROI?
You create a rental income cash flow schedule.
However, creating a cash flow summary can involve a lot of tedious work. It will be particularly time-consuming if you are going to consider taxes to calculate an after-tax ROR.
This Rental Property Calculator (aka Rental Income Calculator, Investment Property Cash Flow Calculator, or Real Estate Investment Calculator) removes the tedium from the task.
Tip: Before you start changing inputs, I suggest you click on the "Cash Flow Schedule" first. This way, you get to see what you are working towards before you worry about understanding the requirements for each input and drop-down. (If you have changed an input and the cash flow schedule doesn't display, refresh the page.)
At this point, we are going to have to get into the weeds of US Tax code. The calculator adheres to the Internal Revenue Code (IRC) as closely as possible. Where appropriate, I will note exceptions. However, the investor should not get bogged down with details that may not be thoroughly understood. For example, depreciation recapture could have a tax impact depending on circumstances and past tax filings. But it is not an issue until you sell the property. And if you are creating an analysis that spans 20 years, who's to say what the tax code will stipulate at the time of the sale?
Let's get started. What follows is an explanation of every input.
Options, settings, and inputs explained
Purchase Price - The closing price or contract price of the rental property. In tax terms, the closing price is the "basis."
Value of Land - Estimate the value of the land. The estimated value gets deducted from the "Adjusted Basis." Per IRS Publication 527 Residential Rental Property 2016, p.6, "Certain property cannot be depreciated. This includes land and certain excepted property. You cannot depreciate the cost of land because land generally does not wear out, become obsolete, or get used up."
Additions to Purchase Price - When buying a rental property, taxpayers cannot expense (deduct from income), all the costs associated with purchasing and preparing a building for use. You must depreciate some expenses related to closing and developing a building for use. (That is, you cannot immediately expense them.) Here is where you include all one-time costs that you cannot expense per the IRC.
The calculator adds these costs to the purchase price to calculate the "Adjusted Basis."
Per IRS Publication 551 2016, Basis of Assets, p2, "the following items are some of the settlement fees or closing costs you can include in the basis of your property":
- Abstract fees (abstract of title fees).
- Charges for installing utility services.
- Legal fees (including title search and preparation of the sales contract and deed).
- Recording fees.
- Transfer taxes.
- Owner's title insurance.
- Any amounts the seller owes that you agree to pay, such as back taxes or interest, recording or mortgage fees, charges for improvements or repairs and sales commissions.
And from Publication 527, p5, "Improvements. You must capitalize any expense you pay to improve your rental property. An expense is for an improvement if it results in a betterment to your property, restores your property, or adapts your property to a new or different use.":
- Additions such as bedroom, bathroom, deck
- Lawn & Grounds including landscaping, driveway, walkway, fence
- Miscellaneous items such as storm windows, doors, new roof, central vacuum, wiring upgrades
- Interior Improvements, for example, built-in appliances, kitchen modernization, flooring, wall-to-wall carpeting
Business Use - Set this to 100% unless you use part of the structure for personal use. For example, if the rental building has three equally sized rental units and you live in one and rent two, then set business use to 66.6% (two-thirds). Business use impacts the depreciation calculation.
Estimated Selling Price (FV) - The rental income calculator creates a cash flow statement from the time you purchase the property until you sell it. The selling price determines the capital gain or loss. Set this to "0" and the calculator will calculate it using the "Annual Appreciation" rate.
Annual Appreciation - If you do not want to estimate a selling price but rather instead assume a set rate of appreciation, set the property's appreciation rate here. Note, if you set neither the "Estimated Selling Price" or "Annual Appreciation" price to zero, then to keep both in sync, the calculator will recalculate "Annual Appreciation."
Closing Date (purchase date) - The day the buyer takes ownership of the property and the closing date for the mortgages. The day the expenses start.
In Service Date - The day rental income and depreciation start. "In Service Date" and "Closing Date" may be the same day. If they are not the same date, then the "In Service Date" must be the first of any month after "Closing Date."
Other rental income calculators don't offer this flexibility. That's sub-par. What happens if an investor needs time to renovate the property? It is feasible that a property is not ready to rent for months after closing, and the delay impacts cash flow.
Date Property Sold - In almost all cases, you'll be entering an estimated date. The date you enter determines the length of the cash flow statement that the calculator prepares.
Estimated Selling Costs - Usually, this is the commission paid to the real estate broker and well as fees to the attorney. There may be other costs as well.
Initial One-Time Expenses - are payments made that can be expensed (not depreciated) in the first tax year. "Initial One-Time Expenses" have no impact on the basis.
Per Publication 551 (2016) Basis of Assets, p2,
The following items are some settlement fees and closing costs you cannot include in the basis of the property.
- Casualty insurance premiums.
- Rent for occupancy of the property before closing.
- Charges for utilities or other services related to occupancy of the property before closing.
- Charges connected with getting a loan. The following are examples of these charges.
- Points (discount points, loan origination fees).
- Mortgage insurance premiums.
- Loan assumption fees.
- Cost of a credit report.
- Fees for an appraisal required by a lender.
- Fees for refinancing a mortgage.
Monthly Expenses - are ongoing charges that occur during the term of the cash flow. "Monthly Expenses" must, for accurate analysis, include expenses that do not happen monthly but none-the-less impact cash flow. If an expense occurs quarterly, for example, prorate it to a monthly value. A $600 quarterly property and casualty insurance premium is $200 a month.
Expenses get deducted from income.
Per IRS Publication 527, Residential Rental Property (2016), p3, Listed below are the most common rental expenses:
- Auto and travel expenses.
- Cleaning and maintenance.
- Interest (other).
- Legal and other professional fees.
- Local transportation expenses.
- Management fees.
- Mortgage interest paid to banks, etc.
- Rental payments.
Annual Expense Increase - An estimate by how much your monthly expenses will increase each year. Set the value to between 0% and 99%.
Annual Property Taxes - Enter the annual amount even if paid quarterly or monthly. Property taxes impact cash flow and are deductible from US Federal taxes as an expense. Even if you pay property taxes quarterly, enter the annual total.
Annual Property Tax Increase - Enter an estimate for how much you expect property taxes to increase each year. If you expect them to fall over time, you can enter a negative value. (Yeah, right.)
Monthly Rent Total - Enter your maximum monthly rent totals. This input, plus the "Monthly Service Income," account for your entire income stream. Enter an amount that assumes you have all units rented 100% of the time.
Monthly Service Income - If you offer additional services to tenants that you charge for, enter the prorated monthly total. Income is increased by the amount you enter here.
Annual Rent Increase - Landlords like to be able to increase rents to improve cash flow, cover rising costs, and improve their rate-of-return. Enter the annual percentage you expect to
Occupancy Rate - For a more accurate analysis, you probably should not assume that you'll be able to rent all units 100% of the time. The percentage you enter here adjusts the income to allow for vacancies. Expenses are not adjusted.
Why is the default "Occupancy Rate" 95.8%?
Simple we are assuming each rental unit is vacant one month out of every two years (1/24). The result is, the income portion of the cash flow statement will reflect 95.8% of the total maximum amount you entered for "Monthly Rent Total" and "Monthly Service Income."
Initial Upfront Investment
Cash Required - Calculated. The "purchase price" + "initial improvements" - "mortgages or loans" + "points." If you want to finance the initial improvements, but their cost is not included in the mortgage, use the second loan option to cover their cost.
Mortgages, Debt and Loan Calculators
This Rental Property Calculator includes two, fully functioning loan calculators, and the cash flow analysis will incorporate two debt streams, if needed, in the statement.
You may enter "0" or "Unknown" for any ONE of the following.
- Mortgage amount
- Annual interest rate
- Number of monthly payments
- Monthly payment amount
When you click "Calc" or "Schedule Preview," the unknown input will be calculated.
IMPORTANT: You may also enter all four values, and the calculator will use them. Recalculation will not occur.
Not recalculating is a double edge sword.
This feature is particularly useful in the event you've arranged for financing with special terms. The calculator will support your negotiated loan terms.
But, you need to be aware, after you've calculated an unknown value, such as payment amount, the calculator will continue to use it. If you change the loan amount, set the payment amount to 0 to recalculate.
Amortization Method - If you finance the property with a traditional mortgage, leave this set to "Normal." Otherwise, as you can see, this you may select interest-only loans, Canadian loans, or no-interest loans. (Perhaps a relative is financing part of your investment?)
Loan Origination Points - Points are an upfront payment made in exchange for a lower interest rate. Points are a percentage of the amount borrowed. One point is one percent. If the mortgage is $500,000 and the lender wants 2 points for a lower interest rate, then you'll pay $10,000 as "points" at closing.
Warning: points, while handled correctly in the cash flow, are NOT incorporated into the tax calculation correctly. When handled correctly, points get neither expensed as a lump sum nor do they get depreciated.
IRS Publication 527 (2016), p 4, states:
"The method used to figure the amount of points you can deduct each year follows the original issue discount (OID) rules. In this case, points are equivalent to OID, which is the difference between: the amount borrowed (redemption price at maturity, or principal), and the proceeds (issue price)."
Since I have never studied this calculation, I've included the points in the depreciation. This treatment will probably have the effect of understating the tax impact. When calculated using OID rules, any refund will most likely be, on a relative basis, somewhat larger, or any tax payment due will be slightly smaller.
Deductible Closing Costs - You can expense some (very few!) fees associated with obtaining a mortgage in the tax year you took out the mortgage. This input is where you enter the total deductible charges.
Here are some examples of fees and charges you can immediately deduct.
IRS Publication 527 (2016), p 7, states:
"The following are settlement fees and closing costs you cannot include in your basis in the property." (Which means you expense them.)
- Fire insurance premiums.
- Rent or other charges relating to occupancy of the property before closing.
- Charges connected with getting or refinancing a loan, such as:
- Points (discount points, loan origination fees),
- Mortgage insurance premiums,
- Loan assumption fees,
- Cost of a credit report, and
- Fees for an appraisal required by a lender.
(The following details are provided as guidelines to help you use the calculator. While I attempt to keep the information accurate and current, I can't keep up with all the subtle changes to IRS regulations and maintain this site too. If you feel a particular tax item is crucial to your cash flow analysis, please confirm the information with the original IRS source or your accountant.)
Marginal Tax Rate - The marginal tax rate is the percentage of tax a taxpayer pays on the next dollar earned. The marginal rate for each taxpayer depends on their income and filing status. You may check the details on the IRS.gov website.
For tax year 2019, the US income tax brackets are:
- 37 percent, for individual single taxpayers with incomes greater than $510,300 ($612,350 for married couples filing jointly);
- 35 percent for incomes over $204,100 ($408,200 for married couples filing jointly);
- 32 percent for incomes over $160,725 ($321,450 for married couples filing jointly);
- 24 percent for incomes over $84,200 ($168,400 for married couples filing jointly);
- 22 percent for incomes over $39,475 ($78,950 for married couples filing jointly);
- 12 percent for incomes over $9,700 ($19,400 for married couples filing jointly).
- The lowest rate is 10 percent for incomes of single individuals with incomes of $9,700 or less ($19,400 for married couples filing jointly).
Capital Gain Tax Rate - If the investor sells the property for more than the "Adjusted Basis" there is a capital gain, and the investor will usually have to pay a capital gain tax. Enter the tax rate used to calculate the tax due on the gain.
The cash flow statement shows your projected capital gain or loss in the "Sold" row in the "Profit and Loss" column.
"The tax rate on most net capital gain is no higher than 15% for most taxpayers. Some or all net capital gain may be taxed at 0% if you're in the 10% or 12% ordinary income tax brackets. However, a 20% tax rate on net capital gain applies to the extent that a taxpayer's taxable income exceeds the thresholds set for the 37% ordinary tax rate ($425,800 for single; $479,000 for married filing jointly or qualifying widow(er); $452,400 for head of household, and $239,500 for married filing separately)" (As of August 1, 2019)
"There are a few other exceptions where capital gains may be taxed at rates greater than 15%:"
"3. The portion of any unrecaptured section 1250 gain from selling section 1250 real property is taxed at a maximum 25% rate."
Recapture Tax Rate - This tax rate has to deal with depreciation recapture. Personally, I find this to be a very (unnecessarily) complicated topic. You can read about it in IRS Publication 544, p29. There you'll find a section devoted to "Depreciation Recapture."
Adjusted Basis - Calculated. "Purchase Price" plus "Additions to Purchase Price " equals the "Adjusted Basis." The "Estimated Selling Price" minus the "Adjusted Basis" plus "Estimated Selling Costs" equals the capital gain or loss.
Depreciation Basis - Calculated. "Adjusted Basis" minus "Value of Land" equals the "Depreciation Basis."
Depreciation Method - The Rental Income Calculator carefully follows all the requirements in IRS Publication 946, How to Depreciate Property regardless of the depreciation method selected. You should check with your accountant about the exact depreciation method to use. However, a reasonable one to choose is "GDS Straight Line." If you pick this one, you'll get a slightly greater tax benefit than if you select ADS straight line. It is not as aggressive of a method as the two declining balance (DB) methods.
Also, if you pick a straight line method, per p.30, IRS Publication 544, you'll avoid taxes for depreciation recapture at the time you sell the property (assuming you held the property for more than one year):
You will not have additional depreciation if any of the following conditions apply to the property disposed of. You figured depreciation for the property using the straight line method or any other method that does not result in depreciation that is more than the amount figured by the straight line method;
Accordingly, residential rental property is depreciated for 27.5 years under the General Depreciation System (GDS) and for 40 years under Alternative Depreciation System (ADS).
Want to learn more details about depreciation? See this MACRS Depreciation Calculator.
Suggestions for tax rate settings
Do NOT take anything you read here (or anywhere on this site) as tax advice. I am explicitly NOT qualified to give such information. I'm offering suggestions and examples, so you'll understand the options. If you are going to invest, you should still consult an attorney or tax accountant.
Marginal tax is straight forward. For accurate results, you'll need to enter your marginal tax rate. This rate is used to calculate "Taxes Due" in every row of the schedule except in the row labeled "Sold."
Calculating taxes on capital gains ("Taxes Due" in the "Sold" row) is more complicated than calculating the tax on ordinary income. There are two parts to the calculation, each taxed at a different rate:
- Tax on the depreciation recapture portion of the gain
- Tax on the balance of the gain.
If this is too much detail for you to be concerned about, no problem. Set both "Capital Gain Tax Rate" and "Recapture Tax Rate" to the same percentage. Setting both to the same rate will tax the entire gain at one rate.
If you want to account for depreciation recapture, then set the "Recapture Tax Rate" as needed. The tax gets calculated on the portion of the gain, up to the total "Accumulated Depreciation," using that rate. The tax on the balance of the capital gain, if there is any, is calculated using the "Capital Gain Tax Rate."
Tax Effects - This setting affects income tax calculations. If you select "All Advantages," the default, then depreciation and loan interest reduce the profit (or increases the loss) and lowers the taxes due (or increases the refund). When "No Depreciation" is selected, depreciation does not get calculated and the profit increases (or the loss narrows). When "Not considered" is selected, neither depreciation or loan interest gets deducted.