Calculating the cash flow from a rental property investment will reveal how economically sensible the investment is. Here's how to do it.

First, calculate taxable income or loss from the property. Taxable income or loss is rent received minus three types of expenses: operating expense, depreciation, and mortgage interest expense.
Assume the purchase of a single-family house for $125,000, of which $25,000 applies to the land and $100,000 to the building. Depreciation of the building cost is tax deductible, even though depreciation is not paid out in cash each year. However, the deduction can be spread over its ‘estimated useful life' – for the purposes of discussion, presume the estimated useful life is 50 years.
Divide the $100,000 cost of the building by 50 years. Your depreciation expense is $2000 per year.
Assume you paid $30,000 and got a mortgage loan of $95,000 for 25 years at 10 per cent.
The first year's payments would be $10,359 including about $9459 of tax-deductible interest.
Suppose the property is rented for $12,000 a year, and the total operating expenses paid by the owner, such as rates, insurance, and repairs, is $2,500.
Subtract from rental income of $12,000 the three types of expense: depreciation ($2000), interest expense ($9459), and operating expense ($2500). The result, for tax purposes, is a rental loss of $1959.
Here's how your rental loss could affect your income tax.
The rental loss could be deducted from other income such as salary, interest, and dividends. We are assuming here that your gross income exceeds $38,000 but does not exceed $60,000 and as such your tax rate is 33 per cent.
Multiply the rental loss by your income tax rate (in our example, 33 per cent). The tax ‘relief' as a result of this deductible rental loss is $646.

Cash flow can now be calculated:
Rental income
Plus: Tax savings
Less: Operating expense
Less: Mortgage payments
$12,000
+ 646
- 2500
- 10,359

CASH FLOW LOSS = $213

The investment nearly breaks even on cash flow. The owner's equity in the property increases each year as the mortgage loan is paid down. Any increase in the property value during the years of ownership will increase the owner's ultimate return.
Calculating the cash flow on a rental property investment you're considering will help decide whether the investment is a good one. It is advisable to avoid investments with a negative cash flow because they incur additional operating costs and debt payments.

By Barrie Singleton, Residential Property Solutions