Cash reserves and taxation

[Tyler Henfling]

When putting together our first multifamily deal, we built in a cash reserve to be used over a five-year hold for such things like capital improvements and unit upgrades. We don't anticipate using all this money in year one obviously, so my question is whether or not that cash reserve is taxed each year? Thoughts and insight would be greatly appreciated!

[Michael Plaks]

@Benjamin A Ersing  @Tyler Henfling

Your questions come from the same fundamental mistake when thinking about taxes: combining the source of money and the use of money. The two are completely separate. No such thing as "net loss" between the two for tax purposes.

Source of money is where the money came from, and it controls whether it is taxable as an income. If it came from your savings account - not taxable. If you pulled it out of your non-Roth IRA - taxable. If it was from rents - taxable. If it was proceeds from the sale of a property - partially taxable. Etc.

The use of money, in contrast, controls whether it is deductible as an expense. If it is used as a down payment or rehab of a rental - depreciated. Invested in a syndication - capitalized into basis for future deduction against the sales price. Spent on marketing - deductible. Etc.

Sitting idle and not doing anything - not taxable, except for the interest earned on it if any, and not deductible.

Again, the two sides of money flow, in and out, cannot be combined for tax purposes. Think of them as two separate transactions, and you should have the right tax answer.