Cash flow and Taxes

[spark1]

Hi Real Estate Gurus,

I ask you help to clarify me the cash flow question and taxes on cash flow.
For sake of simplicity let`s assume the following:

Rent: $1,000
Mortg Interest: $300
Mortg Principal: $300
Expenses: $300
CashFlow: $100

Sounds great? Sure, as REIN teaches us I have a $100 cash flow positive property plus tenants pay my mortgage down.
However, when I start to think about CRA the picture is not so great.

Cashflow BEFORE taxes: $100
Taxable income: $400
Cashflow AFTER taxes: -$100

Basically I am loosing $100 every month. Not a great deal anymore. Surely I understand that at time of sale I will have a $300 profit (appreciation) which again will be taxed and the net will be only $150.

Also, am I right that I pay taxes TWICE on the same rent. The mortgage principal is taxed twice: then I get it in a form of rent and after the disposition of the property.

Am I doing my calculations right? Thank you very much for you thoughts.

 

[Thomas Beyer]

QUOTE (spark1 @ Aug 14 2010, 06:43 AM) ..Am I doing my calculations right? ..
You can depreciate the asset by 4% of the house value annually. Not land.

So let`s say your property is worth $200,000. Let`s say $50,000 is the land value. 4% of $150,000 house value is $6000/year.

You deduct up to $6000/year from your (pre-tax) operating income to arrive at taxable income .. and: voila: no taxes payable .. until you sell the asset or NOI increases to over $6000/year due to low mortgage payments or higher rents .. usually only after 10 or 15 years of property ownership or so !

CRA calls depreciation CCA (capital cost allowance). You will have to pay this tax savings back when you sell .. it is called CCA recapture. Really it is tax deferral !

 

[gwasser]

QUOTE (spark1 @ Aug 14 2010, 06:43 AM) Hi Real Estate Gurus,

Basically I am loosing $100 every month. Not a great deal anymore. Surely I understand that at time of sale I will have a $300 profit (appreciation) which again will be taxed and the net will be only $150.

Also, am I right that I pay taxes TWICE on the same rent. The mortgage principal is taxed twice: then I get it in a form of rent and after the disposition of the property.

Am I doing my calculations right? Thank you very much for you thoughts.


No you are wrong with being taxed twice. Appreciation of the property value is part of the cap gains on your initial investment (down payment plus acquition and sale costs), it does not include the mortgage paydown. Exception is when you depreciate as Thomas suggests, that is a form of tax deferral. If this sounds complex, that is because it is complex so better sit down with your accountant.

 

[spark1]

QUOTE (ThomasBeyer @ Aug 14 2010, 11:14 AM) You can depreciate the asset by 4% of the house value annually. Not land.

Thomas, thanks, great point about CCA. I have not used it yet and forgot that it exists.

Godfried, thanks, you are right. Now I see, no double taxation. However, it is still not a pleasant thing to pay taxes now (for mortgage paydown) for your future gains (e.g. if CCA is not sufficient or exhousted).

Thank you a lot!

 

[Thomas Beyer]

QUOTE (spark1 @ Aug 14 2010, 04:35 PM) ..However, it is still not a pleasant thing to pay taxes now (for mortgage paydown) ..
view taxes differently: if you pay taxes: YOU MADE MONEY. Not everyone can say that in real estate.

Also, likely for the first 5-10 years of a rental project CCA offsets any taxable income, unless the rents are superbly high or your mortgage (as loan to value) is very low !

 

[nemesisb13]

QUOTE (ThomasBeyer @ Aug 14 2010, 10:14 AM) You can depreciate the asset by 4% of the house value annually. Not land.

So let`s say your property is worth $200,000. Let`s say $50,000 is the land value. 4% of $150,000 house value is $6000/year.


I`ve just recently joined the REIN forums and I have a question regarding the depreciation applied to the building:
Thomas, is the depreciation applied to the portion of the price paid for the building or on the value of the city`s evaluation?

For example:

Purchase price : 400000

City (municipal) evaluation building: 250000
City (municipal) evaluation land: 50000
City (municipal) evaluation Total: 300000

Would I apply the depreciation on the 250000 (municipal evaluation) or on ~333333 ( = 400000*(250000/300000), which is the portion the building represents on the purchase price).


I am investing in Quebec right now so I don`t know the rules surrounding properties in other provinces regarding the concept of "city evaluation" (where the city assigns a value to the property and land, and is usually quite lower than the market asking price).

Also, I`m in the process of locating an accountant who deals in real estate income taxes since they are much more involved than personal income taxes...

Thanks in advance.

 

[Thomas Beyer]

QUOTE (nemesisb13 @ Sep 14 2010, 02:40 PM) Thomas, is the depreciation applied to the portion of the price paid for the building or on the value of the city`s evaluation?
use a best guess estimate. There is no hard rule. Use what is realistic. What is the land worth without the house on it ? In Point Grey in Vancouver or Mt. Royal in Calgary or Bridlepath in Toronto, with a tear down, 95% of the price might be land. In a fairly new house in an "average" suburb, land might be 25% or so. In an 30 year old house in an average sub-division land might be 35 to 50%.

As an expert in real estate you should know, more or less, what raw land is worth in that neighborhood. If you don`t: do more due diligence !!

 

[nemesisb13]

QUOTE (ThomasBeyer @ Sep 14 2010, 02:45 PM) use a best guess estimate. There is no hard rule. Use what is realistic. What is the land worth without the house on it ? In Point Grey in Vancouver or Mt. Royal in Calgary or Bridlepath in Toronto, with a tear down, 95% of the price might be land. In a fairly new house in an "average" suburb, land might be 25% or so. In an 30 year old house in an average sub-division land might be 35 to 50%.

As an expert in real estate you should know, more or less, what raw land is worth in that neighborhood. If you don`t: do more due diligence !!


Thanks for your perspective, Thomas. I hadn`t considered that way of looking at land/property values. I have a little more homework to do here in Quebec to get those numbers.

Thanks again.

 

[Thomas Beyer]

QUOTE (nemesisb13 @ Sep 14 2010, 03:00 PM) I have a little more homework to do here in Quebec to get those numbers.
Why invest in Quebec ? Is there decent upside ?

 

[moparcanuck]

QUOTE (nemesisb13 @ Sep 14 2010, 04:00 PM) Thanks for your perspective, Thomas. I hadn`t considered that way of looking at land/property values. I have a little more homework to do here in Quebec to get those numbers.

Thanks again.

Thomas is right. There is no hard and fast rule on the split. However, you must remember to

1. Be reasonable. You have to be able to justify to a third party (CRA) HOW you got those numbers.
2. Document it. So that if/when you do get asked, you can show how you got it.
3. Be consistent. If you`re buying similar properties, the method of how you got the numbers should be similar as well.

 

[nemesisb13]

QUOTE (ThomasBeyer @ Sep 14 2010, 05:50 PM) Why invest in Quebec ? Is there decent upside ?


Hi Thomas.

I’ve decided to invest in multifamily real estate in Quebec because I live there. My intent is to invest and partially manage the property myself with my parents, so being close to it will be important.

Though prices vs rents are definitely not always the best in Quebec, especially in large urban centers as in Montreal and Quebec City (partially due to rent control but more to do with speculation which was skewed the market), I’m more interested in investing in the smaller urban centers of Quebec where I still see some potential. Obviously the numbers still have to make sense and the building must have potential, otherwise I will not invest in it.

I’m also using your A-Z checklist, posted on another thread on the forum, as another way to gauge if the property I’m considering makes sense on more than just the numbers.

Eventually I will start investing in Ontario since I’ve seen the rents can be almost double in certain areas without the property being exorbitantly high-priced.


Thanks moparcanuck for your feedback as well.

 

[Thomas Beyer]

QUOTE (nemesisb13 @ Sep 15 2010, 05:44 AM)
I`ve decided to invest in multifamily real estate in Quebec because I live there. ..

..


Keep in mind the rather socialistic rent collection/eviction rules in Quebec .. so not only can you not raise rents efficiently but you also have a harder time getting rid of frequent late- or non-payers !



I made the mistake of buying a 3BR condo in Knowlton, PQ two years ago .. as it was rental pooled and seemed well priced .. BIG MISTAKE .. high vacancy .. rent collection issues galore .. falling rents ..



Does the target city in Quebec stack up well in the Property Goldmine Scorecard developed by REIN: http://myreinspace.com/downloads/critical_forms/m/due_diligence_forms/55.aspx ???

 

[Mike Milovick]

There has been some excellent input to your question.

I might suggesting investing $60 or $70 on Landlord Cash Flow Anaylzer Pro (Canada). Download it. It gives you, among other thigns - cash flow before and after tax - and factors in depreciation - to give you a true financial picture of your prospective investment.

If you put in promo code "Realtor Mike" or "RealtorMike" you may get $10 off. (I don`t get a kick back.

)

Happy Investing,
Mike

QUOTE (spark1 @ Aug 14 2010, 08:43 AM) Hi Real Estate Gurus,

I ask you help to clarify me the cash flow question and taxes on cash flow.
For sake of simplicity let`s assume the following:

Rent: $1,000
Mortg Interest: $300
Mortg Principal: $300
Expenses: $300
CashFlow: $100

Sounds great? Sure, as REIN teaches us I have a $100 cash flow positive property plus tenants pay my mortgage down.
However, when I start to think about CRA the picture is not so great.

Cashflow BEFORE taxes: $100
line-height:100%">Taxable income: $400
Cashflow AFTER taxes: -$100

Basically I am loosing $100 every month. Not a great deal anymore. Surely I understand that at time of sale I will have a $300 profit (appreciation) which again will be taxed and the net will be only $150.

Also, am I right that I pay taxes TWICE on the same rent. The mortgage principal is taxed twice: then I get it in a form of rent and after the disposition of the property.

Am I doing my calculations right? Thank you very much for you thoughts.

 

[nemesisb13]

Thanks for the link to the software, Mike. It looks like a really good tool. I had created my own analysis tool with excel but this software seems to be more information.

Thomas, I was trying to open the link you included to the Property Goldmine Scorecard developed by REIN but it seems to be accessible only to REIN members. The only Property Goldmine Scorecard I have is the one from Don`s book to which I have added my own criteria from other sources. Is there another way to access the one you posted in your reply?

Thanks again.

 

[Thomas Beyer]

QUOTE (nemesisb13 @ Nov 18 2010, 08:34 PM) .. The only Property Goldmine Scorecard I have is the one from Don`s book to which I have added my own criteria from other sources. Is there another way to access the one you posted in your reply?
yes .. join REIN !

Like that famous credit card commercial .. membership has it privileges !