Tax Deduction

A tax deduction is an expense subtracted from income before tax is calculated. Rental owners can generally deduct operating expenses, mortgage interest and depreciation. Cash on cash return is quoted before tax, so deductions affect after-tax results but not the standard ratio.

On the default deal, deductible items in year one include about $19,070 of operating expenses, $27,068 of mortgage interest and depreciation on the building. Principal payments are not deductible, which is why cash flow and taxable income never match.

Deductions can make a rental show a small tax loss while it deposits real cash. Whether that loss can offset other income depends on passive activity rules and the owner's situation. Model the pre-tax return first, then ask a tax professional what the deductions are worth to you.

Further reading: Tax Deduction on Wikipedia.