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Lecture+10+FNCE+232+Tax+Analysis+of+Real+Estate+Investing

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FNCE 232 Lecture 10 Tax Analysis of Real Estate Investing Professor C. F. Sirmans
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Administrative Issues Exam 2 – Thursday, March 6 Need help? Schedule an appointment with teaching assistants. Don’t wait till the last minute to begin reviewing for exam. Have you reviewed the spreadsheet associated with the cases?
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Lecture 10 -- Overview After-Tax Cash Flows Operation -- ATCF Sale -- ATER Analyzing Tax Effects Taxable Income from Operation Mechanics of Depreciation Taxable Income from Sale Alternative Exit Strategies
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Reading Assignment B & F, Chapter 11
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Tax Effects from Operation Operating a real estate investment generates potential income tax effects. To calculate these tax effects the investor must understand the tax consequences of (i) operating expenses, (ii) debt financing, and (iii) the depreciation deduction.
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Tax Effects from Operation Cash flows Versus Taxable income
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After-Tax Cash Flow From Operation Effective Gross Income - Operating Expenses EGI - OE = Net Operating Income = NOI - Debt Service - DS = Before-Tax Cash Flow = BTCF - Tax Liability - TAXES = After-Tax Cash Flow = ATCF
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Taxable Income and Taxes From Operation Effective Gross Income EGI - Operating Expenses - OE - Depreciation Deduction - DEP - Interest Expenses - INT - Amortized Financing Costs - AFC = Taxable Income From Operation = TI x Marginal Tax Rate x MTR = Taxes From Operation = TAXES
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Tax Calculation To compute the amount of tax (any type, i.e., sales tax, property tax, income tax, capital gain tax), you need two inputs: A. The Amount to be Taxed B. The Tax Rate
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Tax Calculation For investment decision making, the important tax rate is the marginal rate. Marginal Rate versus Average Rate – Example
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Tax Rate Suppose an investor has a Taxable Income of $100,000 and pays $20,000 in taxes. What is the (average) tax rate? Answer: 20% Suppose the investor buys a real estate investment that produces $30,000 in additional taxable income, which results in a tax liability of $29,000 on the $130,000. What is the investor’s marginal tax rate? Answer: 30%
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Steps in Analyzing Tax Effects Determine the tax classification Form of business organization – corporate, individual, partnership, etc. Type of real estate – income-producing residential, other commercial real estate, low-incoming residential, historic property Determine investor’s marginal tax rate Estimate taxable income – acquisition phase, operating phase, disposition phase Compute expected taxes
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Four Classes of Real Property for Tax Purposes Real estate held as a personal residence Real estate held for sale to others– dealer property Real estate held for use in a trade or business– trade or business property Real estate held as an investment for the production of income– investment property
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