Cash Flow and Operating Expenses in Rental Property Management
It's as much about what's not included as what is
The goal of real estate investing is to achieve a positive cash flow while also realizing the other benefits of real estate ownership, such as appreciation and tax breaks. Profitably owning rental property means accounting for both income and operating expenses.
The challenge is to understand what's actually included in operating expenses. A lot of new investors are tripped up by what's not included.
Operating Expenses Don't Include Your Mortgage
"Debt service" is a major component of cash flow, positive or negative. A monthly payment is necessary for non-cash purchases.
But when you're evaluating possible rental property purchases and you see a figure in the financials for operating expenses, a mortgage payment isn't included in that number. You'll not only have to pay those other expenses, but your principal and interest payments as well. Always be sure to analyze the cash flow of the investment with great care.
Rental Property Operating Expenses
There are few surprises in what is included in operating expenses, although identifying them and calculating them can be tricky in some cases.
- Marketing and advertising: You can deduct expenses associated with running ads for tenants, as well as for hosting and maintaining a website or blog dedicated to your rental business.
- Property taxes: Break them out and deduct them in the year they're paid even if they're included in your mortgage payment.
- Insurance: Your annual insurance premium is deductible as an operating expense even though it might also be escrowed and included in your mortgage payments.
- Utilities: You can deduct as an operating expense any utilities that you pay, including water and sewer.
- Trash collection: This is usually a monthly municipal charge, and it's a valid operating expense.
- Management: You can deduct the cost in the year paid if you hire professional management.
- Maintenance and repairs: You can't deduct major items like renovation, although they're often depreciable for tax purposes. You can deduct normal maintenance and repairs to the dwelling, however.
- Landscaping and pool care: These are operating expenses and they're deductible as well.
- Accounting and legal: Fees you pay to an accountant or attorney related to work performed for your rental property are deductible as operating expenses.
- Snow removal and pest control: These are valid operating expense deductions as well.
Another Expense That's Not an Expense
Depreciating your rental property is one of the major perks involved with cash flow—the money you either take out of your pocket or put into your pocket from your rental enterprise. But it's not included in your operating expenses.
The IRS allows you to depreciate a rental home over 27.5 years. Take the value of the home and subtract out the land value. Now divide the result by 27.5 to get the annual amount you can claim as a tax deduction.
Remember, this is money you really haven't spent. It's just a calculation for tax purposes. Consult with an accountant to nail down the finer details.
The Bottom Line
Positive monthly cash flow is a primary reason why many investors choose rentals as their real estate investment niche. It can provide great income, and you'll build equity over time as well. That monthly check multiplied by several rental properties can fund your retirement quite well. Steady income from rental property can be long-term.