Do you pay taxes on cash flow ????

[Ricardo A Perez]

Hey BP family ! Any CPA’s out there lol  .  I am a new investor and I have been taught the formula goes like this Income-expenses = cashflow but, my question is do you pay taxes on that “cashflow” ? If so, how much should I be setting a side to pay on taxes. Thank you in advise for responding ! 

[Nicholas Aiola]

@Ricardo A Perez I'll try to consolidate some of the responses...

You do NOT pay tax on cash flow; you pay tax on taxable income. Cash flow almost never equals taxable income. The main contributor to this difference is depreciation. Depreciation expense is a non-cash deduction that reduces taxable income but does not reduce your cash flow. 

Residential real estate is depreciated over 27.5 years but it's much more complicated than taking the purchase price and dividing by 27.5. You have to factor in closing costs, break out the portion allocated to land since land is not depreciable, separate the loan costs and amortize them over the life of the loan, etc.

If the property is sold (absent a 1031 exchange), you will have to recapture the depreciation up to the amount you benefitted from the depreciation deductions while you held the property. This is called Unrecaptured Sec. 1250 Gain. This gain exists whether or not you actually deduct depreciation expense, so it's extremely important to calculate basis correctly, deduct depreciation each year, and calculate the unrecaptured Sec. 1250 gain correctly in the year of sale.

It can get complicated quickly but if you plan to DIY it, make sure your verify your source information.