Income Tax Considerations

1
Income Tax Considerations

• Converting to after tax cash flows

2
Non-Cash Expenses

• Depreciation
• Non cash expense based on original purchase
  price of a hard asset
• Depreciated over time (useful life of the asset)
• Generates non cash losses for investors to offset
  income on tax returns
• After tax cash flow will reflect actual amount of
  taxes paid or tax savings after depreciation and
  amortization of assets

3
Depreciation Calculation

• Straight Line over useful life of the asset
• Buildings use 27.5 years
• Divide building price or development price by
  27.5
• Land does not depreciate

4
Example of Depreciation
Assume 2.3M purchase price in previous example
is divided 500K Land and 1.8 M Building.
Depreciation Calculation

Year 1 2 3

Beginning Balance 1,800,000 1,734,545 1,669,091
Less Annual Depreciation 65,455 65,455 65,455
Ending Balance 1,734,545 1,669,091 1,603,636
5
An Example of Book Value
Net Book Value
Land 500,000 500,000
Building 1,800,000 1,800,000
Accumulated Depreciation 65,455 130,909
Net book value Building 1,734,545 1,669,091

Total Asset book value 2,234,545 2,169,091
At the end of year two the property may be worth
more than 2.1 M market value but the book value
remains at purchase price less depreciation.
6
Non-Cash Expenses

• Amortization
• Some soft costs may be capitalized and amortized
  over a period of time rather than expensed all at
  once
• Accrued Expenses
• Expensed in this year but not paid until a future
  date
• Interest on soft loans
• Popular with tax credit deals

7
Tax Implications

• Total NOI minus interest expense and non cash
  expenses equals taxable income
• Start with NOI
• Less Interest
• Depreciation
• Amortization
• Equals Taxable Income
• X Tax Rate
• Equals Income Tax Due

8
Example Tax Calculation
Assuming a 28 Tax Rate
TAX CALCULATION
1 2 3
NOI - 229,900 229,517

Less Depreciation 65,455 65,455 65,455
Less Interest Expense 128,800 123,674 118,190

Net Taxable Income (194,255) 40,771 45,872

Income Taxes 54,391 (11,416) (12,844)
9
Back to Cash Flow

• Using taxes calculated adjust cash flow statement
  for taxes paid or deductions gained.
• Start with NOI
• Less Debt Service
• Less Taxes paid (if gains)
• Or plus Taxes saved (if losses)
• Equals After Tax Cash Flow
• Should be discounted at the after tax discount
  rate.

10
After Tax Cash Flow
1 2
Gross Rental Income 1,000,000 1,030,000
Vacancy 300,000 72,100
Net Rental Income 700,000 957,900
Operating Expenses 700,000 728,000
NOI - 229,900
Less Taxes Paid 54,391 (11,416)
Less Debt Service (202,022) (202,022)
Purchase Price
Net Cash Flow From Sale
Total After Tax Cash Flow (147,631) 16,462
11
Other Cash Flow Considerations

• Capital Expenditures
• Outflows of cash for capitalized items
• Will not hit expenses
• Capitalized and depreciated over time
• Adds to depreciation expense but cash outflow in
  one year