After-Tax Cash Flow on Rental Property Explained

After-tax cash flow is the cash a rental leaves you once you subtract the tax it causes or add back the tax it saves. It differs from pre-tax cash flow because the tax return and the bank account count different things: depreciation is a deduction you never pay in cash, while mortgage principal and capital reserves are cash you pay that are not deductible. Whether a tax loss actually saves you money this year depends on the passive activity rules and your income.

To run your own property, use the rental property after-tax cash flow calculator. This article explains the rules behind it with a full year-one example.

Cash flow vs. taxable income: what counts where

Rental income and expenses go on Schedule E, and depreciation is figured on Form 4562, per IRS Publication 527. That publication also says improvements (betterments, restorations, adaptations) must be capitalized rather than deducted.

How depreciation creates a "paper" loss

Residential rental buildings are depreciated straight-line over 27.5 years using the mid-month convention (Pub 527). Land is never depreciable. So the first job is splitting your cost basis between land and building, commonly using the ratio on the county assessor's notice.

• Purchase price $300,000; assessor shows 20% land
• Building basis: $300,000 × 80% = $240,000
• Full-year depreciation: $240,000 ÷ 27.5 = $8,727.27

The mid-month convention treats the property as placed in service halfway through the month it became available for rent. If that was January, year one gets 11.5 months: $8,727.27 × 11.5 ÷ 12 = $8,363.64. A property placed in service in August gets only 4.5 months in year one.

Settlement costs such as title fees, recording fees, and transfer taxes are added to basis and split between land and building in the same ratio. Loan costs are not part of the property's basis; points are deducted over the life of the loan.

For the full MACRS tables and shorter-lived components such as appliances and carpet, see our MACRS depreciation guide.

Worked example: year one on a $300,000 rental

Assumptions

• Price $300,000, 20% down, $240,000 loan at 7% for 30 years (payment $1,596.73 a month)
• Rent $2,200 a month, 5% vacancy
• Property tax $3,600, insurance $1,200, management 8% of collected rent, repairs $100 a month, CapEx reserve $100 a month
• Building basis $240,000, placed in service in January
• Investor's marginal federal rate: 24%

Step 1: Pre-tax cash flow

Step 2: Taxable rental income

Year-one interest on the amortization schedule is $16,722.77; the other $2,437.94 of payments is principal.

The CapEx reserve and principal are not here. That is why the tax loss ($8,013) is more than twice the cash loss ($3,287): the return includes $8,364 of depreciation you did not pay, and excludes $3,638 of principal and reserve you did pay.

Step 3: Tax effect

If the full $8,012.81 loss offsets wages taxed at 24%, it saves $1,923. After-tax cash flow becomes −$3,287 + $1,923 = −$1,364 for the year. Whether you get that saving depends on the next section.

Can you actually use the rental loss?

Rental activities are generally passive, and passive losses can offset only passive income — unless an exception applies. Pub 527 lays out the two that matter most.

The $25,000 special allowance

If you actively participate — you and your spouse own at least 10% and make management decisions such as approving tenants and setting rent — up to $25,000 of rental loss can offset nonpassive income like wages. The allowance phases out:

• Modified AGI $100,000 or less: full $25,000
• Above $100,000: the allowance is 50% of ($150,000 − MAGI)
• $150,000 or more: no allowance
• Married filing separately: $12,500 with a $50,000–$75,000 phase-out, and only if you lived apart all year

The same loss for three different investors

At $140,000, the allowance is 50% × ($150,000 − $140,000) = $5,000. At $170,000 nothing is allowed this year. The losses are not lost: Form 8582 carries them forward to offset future passive income, and under IRC §469(g) any remaining suspended loss is generally released in full when you sell the property to an unrelated buyer in a taxable sale.

Real estate professional status

If more than half of your personal services in all businesses are in real property businesses where you materially participate, and those services exceed 750 hours a year, your rentals can be nonpassive (Pub 527). This test is per person and is hard to meet with a full-time job outside real estate. Keep contemporaneous time logs if you claim it.

If you also use the property yourself

Everything above assumes a full-time rental. Pub 527 treats a dwelling as a home if your personal use exceeds the greater of 14 days or 10% of the days it is rented at fair rental price. In that case expenses must be split between personal and rental days, and rental deductions generally cannot exceed rental income, so the paper loss in this example would not be available. If you rent a home for fewer than 15 days in the year, the rent is not included in income and the related expenses are not rental expenses.

How the picture changes over time

Two forces work against the year-one tax loss:

1. Interest falls. On the $240,000 loan, interest drops from $16,723 in year one to $14,592 in year 10 and $12,683 in year 15, while principal rises from $2,438 to $4,569 and $6,477.
2. Rent grows. At 3% a year on both rent and expenses, collected rent reaches about $32,724 in year 10.

With 3% growth, year-10 taxable income is about −$1,042 while cash flow is about +$1,551. By year 15, taxable income is about +$4,415 and cash flow about +$4,850. The tax shelter shrinks just as cash flow turns positive — a reason to project several years rather than judging a rental on year one. The general after-tax cash flow calculator is set up for that kind of multi-year comparison.

What depreciation costs you at sale

Depreciation is a deferral, not a gift. When you sell, your basis is reduced by the depreciation "allowed or allowable" — IRS Publication 544 uses the greater of the two, so skipping depreciation does not avoid the recapture. The gain attributable to that depreciation is unrecaptured section 1250 gain, taxed at a maximum of 25% according to IRS Topic 409.

If the example property is held 10 years, roughly $86,900 of depreciation will have been taken. At 25%, that is up to about $21,700 of federal tax at sale, on top of the regular capital gains tax on any appreciation. The real estate capital gains tax guide works through a full sale, and the real estate capital gains calculator models the regular gain.

Other taxes on rental income

• No self-employment tax on ordinary long-term rental income reported on Schedule E.
• Net investment income tax: rents are investment income for the 3.8% NIIT once modified AGI exceeds $200,000 single or $250,000 joint, per IRS Topic 559. Estimate it with the NIIT calculator.
• State income tax applies in most states and changes the marginal rate you should use.

Mistakes that distort after-tax cash flow

• Depreciating the land. Only the building and improvements depreciate.
• Deducting the CapEx reserve. Money in a reserve account is not an expense; the roof it eventually pays for is capitalized.
• Using a 24% savings rate on a loss you cannot use. Check the passive loss allowance first.
• Approximating interest as balance × rate. That overstates year-one interest on this loan by about $77 and gets worse each year.
• Forgetting recapture. A rental that only works because of depreciation still owes up to 25% on that depreciation at sale.

Next steps

Run your property through the after-tax rental cash flow calculator, then compare the pre-tax metrics in the rental property ROI calculator to see whether the deal stands on its own before the tax effects.