When you're investing in real estate, you want to create a rental property cash flow analysis to make sure you're going to have a positive cash flow and profit. But some investors make mistakes about which costs should be classified as operating expenses. Show
That can skew the outlook for a property, causing you to possibly make a bad investment decision. Or it could result in faulty financial reporting of a property you already own, making it harder to tell how well your rental is actually performing. Here, we'll break down what exactly is and isn't included in operating expenses. Key Takeaways
What Is an Operating ExpenseOperating expenses are costs that are necessary to maintain a property and make sure it can produce income. They're costs that affect the day-to-day operation of the property. What's Not Included in Operating ExpensesIt's helpful to first know what's not considered an operating expense. Mortgage Payments"Debt service" is a major component of cash flow, positive or negative. Monthly payment is necessary for non-cash purchases. But when you're evaluating possible rental property purchases and you see a figure in the financials for operating expenses, a mortgage payment isn't included in that number. That's because financing terms are different for different investors, and your interest rate or down payment aren't predicted upfront. You'll not only have to pay those other expenses but your principal and interest payments as well. Always be sure to analyze the cash flow of the investment with great care. DepreciationDepreciating your rental property is one of the major perks involved with cash flow—the money you either take out of your pocket or put into your pocket from your rental enterprise. But it's not included in your operating expenses. The IRS allows you to depreciate a rental home over 27.5 years. Take the value of the home and subtract out the land value (which doesn't depreciate in value). Now divide the result by 27.5 to get the annual amount you can claim as a tax deduction. Remember, this is money you really haven't spent. It's just a calculation for tax purposes. Consult with an accountant to nail down the finer details. Capital ExpensesMoney you spend on repairs and improvements such as a new roof or a water heater are capital expenses. These can vary by investor, so they're not included in operating expenses. For example, one investor may choose to upgrade fixtures while another does not. Investor Income TaxesProperty taxes are included in operating expenses, but income taxes are not. These are not directly related to the property's ability to produce rental income, so you wouldn't include them in operating expenses. Rental Property Operating ExpensesThere are few surprises in what is included in operating expenses, although identifying them and calculating them can be tricky in some cases. These are considered operating expenses because they're linked to the daily operation of the property and affect its ability to be rented. The expenses listed here are also tax deductible.
Frequently Asked Questions (FAQs)Why is it important to know what costs are included in operating expenses?Accurately estimating operating expenses for a rental property allows an investor to make a correct analysis of the property's potential for generating cash flow. It also helps you identify opportunities for increasing profits. If you already own the property, knowing your operating costs helps you evaluate just how well the property is performing. What is a good percentage for operating expenses for rental property?Depending on the type of real estate, operating expenses may be 35-80% of gross operating income. To calculate the operating expense ratio, you'd divide the monthly expenses by the monthly rent. For a basic house or duplex, this is typically 35-45%. But luxury real estate, such as a vacation home, may have an expense ratio of 70-80%. Which is not included as operating expense?A non-operating expense is a cost that isn't directly related to core business operations. Examples of non-operating expenses are interest payments on debt, restructuring costs, inventory write-offs and payments to settle lawsuits.
What are the 4 operating expenses?Importance of Operating Expenses
With that in mind, costs associated with people, energy, transportation and travel are four types of operating expenditures companies can examine for cost-saving opportunities when they have a clear view of these expenditures.
Which of the following is not an operating expense quizlet?31. Which of the following is not considered an operating expense for appraisal or income tax purposes? Operating expenses include fixed expenses, variable expenses, and reserve for replacements. Mortgage payments, called debt service, are not considered an operating expense.
What are operating and non operating expenses?Operating expenses are all the costs you incur to bring a product or service to market. Non-operating expenses are costs that are not related to normal business operations, such a relocation costs or paying off a loan.
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