Let's start with a premise-you want to buy a profitable rental property.

How would you know if it is going to be profitable? Frankly, you don't. Because whatever you think is going to happen may not happen.

That's true of everything.

So, let's go to the next step. How can we take what we think we know and make a well-reasoned projection of a rental property's profitability-after taxes?

Answer: read this article and use the calculator to find your projected after-tax adjusted rate of return.

Starting Point

What rate of return do you currently earn on investments that you consider safe? Let's say you have an investment that grosses 5.17 percent before taxes and 3 percent after taxes.

Now, let's say you find a rental property that you like and use our calculator to find that this rental will produce, if your projections are right, 279 percent more profits than your safe investment.

Wow! Yes! With the calculator, you can compare your 5.17 percent safe rate with a rental property rate of return.

That's what makes the calculator so cool. In fact, it's so cool that we're going to name it Analyzer.

With the Analyzer, you can take a complicated rental property investment and break it down into one single rate of return that you can compare with other investments. This way, you compare apples to apples-it's a huge advantage.

The Secret to the Analyzer

The Analyzer uses the after-tax adjusted-rate-of-return formula to produce an after-tax number that we gross up to make it comparable to your pretax safe rate.

For example, in the analysis of a sample rental property investment that displays when you open the Analyzer, the Analyzer found that a net cash investment of $43,828 produced $72,080 in after-tax walkaway cash in seven years. That's a 12.7 percent compound return.

Here's how the Analyzer drills down to come up with the 12.7 percent comparable return.

$43,828 is the after-tax present value of all the cash put into this investment over the seven-year period of ownership.
$72,080 is the after-sale, after-tax, after-mortgage-payoff proceeds plus the after-tax future value of the annual positive cash flows as they occur. In other words, this is the cash in your pocket after the sale is complete.
The Analyzer uses the present value, the future value, and an annuity due function to calculate the annual after-tax adjusted rate of return of 7.37 percent.
Since the 7.37 percent is after tax, the Analyzer divides it by the after-tax rate to find the pretax return for comparison with the pretax safe investment rate. Thus, you can compare the 5.17 percent safe rate to the 12.7 percent rental property profit rate.

The Analyzer takes the hocus-pocus out of the comparison. You could make the rental property decision knowing that your rental property projections show a possible 245.64 percent better financial reward than you are getting with the safe investments.

The Analyzer does the heavy lifting on the rental property.

It calculates the depreciation on the building part,
amortizes the mortgage acquisition costs,
calculates the unrecaptured Section 1250 gain that's subject to the 25 percent capital gains tax (special tax on your capital gains attributable to depreciation),
calculates the capital gains tax on the sale,
adjusts the calculations based on paying off the mortgages,
calculates the present value,
calculates the future value,
considers appreciation of the property,
considers inflation of all the costs,
considers the time value of money, and
gives one easy-to-understand result.

Crystal Ball Cleaner

You have to consider the Analyzer a crystal ball cleaner. To make a sound rental property purchase, you need logic and common sense. The Analyzer allows you to apply your logic and common sense quickly and almost magically to a property.

The Appreciation Factor

The 12.7 percent rate of return comes from a rental where the projected increase in value is 2 percent per year during the seven-year holding period. Let's see what happens when you change your appreciation estimates:

Annual Appreciation	Rate of Return
0 percent	-1.13 percent
1 percent	6.05 percent
2 percent	12.70 percent
3 percent	18.67 percent
5 percent	28.78 percent

The beauty of the Analyzer is that you can easily change the parameters. Suppose you are worried that your 2 percent is too high or too low. Simply change the rate to see the effects. If this property does not appreciate at all, you lose $1,968 after taxes. The Analyzer gives you this information.

Say you really expect something closer to 5 percent appreciation. At 5 percent property appreciation, the Analyzer tells you that on this property, you will earn 28.75 percent compounded annually, pretax. That's

556.68 percent better than your 5.17 percent safe rate. If your input is accurate, the property gives you a net walkaway cash profit of $85,310. The Analyzer tells you so.

Interest Rate Factor

Leverage is a big deal when you buy rental properties because it can multiply your profits. But if the cost of leverage, the interest rate, is too high, your investment return can go sour.

Today's interest rates are high compared with just a few years ago. The beauty of the Analyzer is that it takes the mystery out of the interest rate and other factors. Let's take this property and examine how interest rates affect the rate of return:

Interest Rate	Rate of Return
4 percent	19.34 percent
5 percent	12.70 percent
6 percent	6.65 percent
7 percent	2.04 percent

Note the huge impact that interest rates have on this sample property. (We adjusted the interest rates on both the first and second mortgages.)

Tax Rates

Tax rates, especially how much they will increase, are a hot topic every year.

With the Analyzer, you can factor in tax increases and decreases. We did that below:

Federal Tax Rates			State Tax Rates		Rate of Return
Ordinary	Capital	Recapture	Ordinary	Capital	Rate of Return
35%	15%	25%	7%	5%	12.70%
43%	15%	25%	7%	5%	13.47%
31%	25%	25%	7%	5%	12.31%

Incredible! An increase in the ordinary federal income tax rate produces an increase in the rate of return on this rental property. Wow! You would not think that. And those revelations add to the reasons that the Analyzer is a great tool.

Okay, fine, but what's the logic? What makes a rental property rate of return increase when the government raises ordinary income tax rates?

Tax subsidies!

It works like this. The property in this example produces a tax loss during the seven years before the sale. You deduct the losses either when incurred or when the property is sold depending on your passive-loss status. But either way, the higher ordinary income tax rate increases profits because it subsidizes your losses.

	Losses Passive	Rate of Return
	Yes	12.70%
	No	14.45%
	Yes	13.47%
	No	15.68%

Passive Losses

You know from the above chart that the higher ordinary income tax rate increases your profits because of the tax subsidy. The passive-loss rules control the benefit of your subsidy.

If you can deduct your rental property losses each year as you incur them, then your benefit from the losses increases because you have the money in hand-and it's earning money. Note that this is true at both the 35 percent and 43 percent rates in the table above.

Quick Primer

Here's a short video on using the Analyzer.

Time for You

Okay, we could go on and on, but it's time for you to put your numbers in the Analyzer and watch with glee as your answers display.

Make a change and check the answers.

Then, take the data from your rental properties and enter it in the Analyzer (click here). You will like knowing how your existing and potential rentals will fare under the various scenarios.

Note. For existing properties, enter property data as if you were buying that property today. Use as the down payment the difference between the fair value of the property and its existing mortgages.

Takeaways

The key to understanding whether a rental property is a viable investment hinges on making an accurate, well-reasoned projection of its potential profitability.

This article introduces a novel tool dubbed "the Analyzer" that calculates the after-tax adjusted rate of return, allowing you to understand how a particular property stacks up against other types of investments.
The Analyzer offers a comprehensive breakdown of multiple financial aspects associated with owning a rental property, including depreciation, mortgage acquisition costs, capital gains tax, and the potential impact of property appreciation, among others. It uses this data to give a clear, straightforward rate of return that can be compared directly to the rates for other investment opportunities.
Interestingly, the tool also allows for the adjustment of multiple variables, including changes in property appreciation rates, interest rates, and tax rates. This capacity for customization makes it a highly flexible and insightful tool for you as a property investor.
This article underscores the importance of factoring in tax subsidies when considering a rental property's rate of return. Depending on your passive-loss status, these tax deductions can significantly increase profits.
In summary, the Analyzer enables you to predict the profitability of a rental property investment in a systematic, comprehensive, and easily understandable manner. Its unique comparative feature allows for an informed evaluation against other forms of investments, making it a valuable tool in your financial arsenal.

How to Project If a Rental Property Is a Winner