As a follow up to the last post, there is a point that needs clarification.   First let me explain cash flow and how it may differ from the tax results.  For example, suppose you own a rental property that provides a positive cash flow – rental income less all expenses – of $200/month.  You might think that this would produce $2,400 of taxable income for the year.   Actually this rental will most likely produce a “tax loss” on your return potentially offsetting any other taxable income that you may have.   How is this possible?  Depreciation.

 Depreciation is the process by which you deduct a portion of the purchase price each year over a certain number of years (as defined by the IRS).  For instance, residential rentals are generally depreciated over 27.5 years.  A home with a depreciable basis of $275,000 would produce a $10,000 depreciation expense each year.  Apply this to the example above and your rental property receives the best of both worlds – positive cash flow AND a tax loss!

As I mentioned last time, a financial decision must make economic sense first and tax sense second.  In this case it makes both economic sense (positive cash flow) AND tax sense (tax loss).   This may be a relatively simple point to analyze.   I just felt the need to clarify the fact that real estate could produce a loss (tax) and still make sense to pursue.