# LOS 74.f

LOS 74.f: Calculate the net operating income from a real estate investment…and the after-tax cash flows of a real estate investment. Question: To retrieve the after-tax cash flow, why does one subtract the principal component of the mortgage payment from the after-tax net income? Is it because it is not tax deductible like the depreciation expense (which you add back fully to net income)?

The EMI paid on the loan for the property has an interest and a principal component. Both are included in cashflows. After tax net income, is after subtracting interest portion from rental income / NOI. To get after tax cash flows, you need to also consider the cashoutflow on account of principal. >Is it because it is not tax deductible like the depreciation expense (which you add back fully to net income)? Principal payment is not deductible from net income, because it is not a revenue item. Depreciation is revenue in nature, but it’s a non cash item.

Oh OK, I think that makes sense now. I guess I didn’t realize that principal is not included in AT net income. Thanks cfa_bombay Wrote: ------------------------------------------------------- > The EMI paid on the loan for the property has an > interest and a principal component. Both are > included in cashflows. > > After tax net income, is after subtracting > interest portion from rental income / NOI. > > To get after tax cash flows, you need to also > consider the cashoutflow on account of principal. > > >Is it because it is not tax deductible like the > depreciation expense (which you add back fully to > net income)? > > Principal payment is not deductible from net > income, because it is not a revenue item. > Depreciation is revenue in nature, but it’s a non > cash item.

to think of it even more simply: remember that a mortgage loan is an amortizing loan with each payment made of interest and principal. I always think of it like this. As each payment is made up of these two components and only interest can be deduced for tax purposed. When we want to see our after tax cash flow we take NOI and add back depcreiation with is a non cash expense and we also add back principal becuase it increases our equity ownership in the project