If you’ve invested in house rentals, chances are you did it to boost your cash flow. But is the cash really flowing?  Read on for a quick rundown on how to calculate you cash flow. This will help you determine whether you’re bringing in a profit that makes your house rentals worth the effort. Knowing your cash flow numbers will also help you decide whether it makes economic sense to continue renting out your properties.

Step 1:  Determine taxable income

To calculate cash flow from your house rentals, you need to start by calculating your taxable income or loss from the property. To do this, first add up the total rent you received over the calendar year. Do this on a per-house basis. You don’t want to add up all the rent you received in one year if you own multiple house rentals. Instead, add up your collected rent total for each house you rent out.

Step 2:  Calculate expenses

The next step is deciphering your expenses as an owner of rental houses. Again, do this on a per-house basis and do not sum the total expenses you’ve accrued if you have multiple properties.

There are three types of expenses to include:  depreciation, mortgage interest expense, and operating expenses.

• Depreciation of the cost of each of your house rentals is a tax deduction. It’s not paid in cash proceeds, but rather is spread out over 27.5 years. To determine the depreciation rate for each of your rental houses, start by finding the cost of the home itself (do not include the cost of the land). Then divide that cost by 27.5 to find out your depreciation expense. For example, if you purchased a house worth $200,000, you would divide that amount by 27.5 to get $7,272. This is your per-year depreciation expense.
• Mortgage interest expense is determined by looking at how much interest you paid on your mortgage over the course of one year. Most mortgage lenders will give you a printed statement at the conclusion of each calendar year that delineates exactly how much interest you paid for the year.
• Operating expenses are expenses paid by you on each of your rental houses to cover things like repairs, insurance, and property tax. Add up the amounts paid in each of these categories on a per-house basis.

Step 3:  Determine rental loss and tax savings

Once you’ve calculated all your expenses, add them up. This means for each one of your rental houses, you’ll add up your depreciation, mortgage interest expense, and operating expenses. Take this sum and subtract from it your collected rent total for the year. The resulting number will tell you your rental loss for tax purposes. Rental loss affects your income tax in a variety of ways. If you are not a real estate professional and your adjusted gross income is not more than $100,000, you can deduct your rental loss (up to $25,000) from other sources of your income. Other sources of income could be salary, interest, and dividends.

To determine how much your rental loss saves you on taxes, multiply your rental loss by your federal income tax rate. The resulting number will tell you how much federal tax you avoided thanks to your deductible rental loss.

Step 4:  Calculate your cash flow

Now that you’ve calculated your rental income, tax savings, expenses, and mortgage payments, you can determine your tax flow. The formula for cash flow is this:  take your rental income and add to it your total tax savings. From that sum, subtract your total annual operating expenses. Next, subtract your total mortgage payments (the total you paid on your mortgage over the course of the year, not simply the amount you paid in interest). The number that results is your cash flow.

Why calculating cash flow is important

An ideal situation is to have a positive number as your total cash flow. Negative numbers will mean you are losing money on your rental house. If you have multiple rental houses, it’s fine to add up all the separate cash flow totals for each house. If this number is in the green, you are doing well with your investment properties, even if one or two of the properties produced a negative cash flow. Be careful though – even when you have a positive total cash flow balance, it’s important to scrutinize any individual rental that gave you a negative cash flow. If that negative cash flow number was significant, it may not be in your best interest to retain the rental property. This is because you’ll be the one required to come up with extra money to cover debt payments and operating costs.

Cash flow helps determine investments

It’s wise to determine the investment potential on rental houses before you decide to become a landlord. This will help you determine whether rental houses are a worthy investment for you. Use averages for annual maintenance costs and rely on good faith estimates you receive from potential lenders.