Tax Shield

A tax shield is the reduction in tax that comes from a deductible expense, such as interest or depreciation. On a rental it can make cash flow partly or fully tax-free, which is why after-tax returns can beat the pre-tax cash on cash return.

On the default deal, NOI of $40,210 less $27,068 of interest and about $14,545 of depreciation leaves a small taxable loss, roughly $1,400. The $9,512 of cash flow is sheltered for the year. Depending on the owner's situation, the loss may also offset other income or carry forward.

Because the shield depends on the owner's tax bracket and passive loss rules, the standard cash on cash figure ignores it. Two investors buying the same property get the same pre-tax return but different after-tax results. Model the pre-tax number first, then layer the tax effect on top.

Further reading: Tax Shield on Wikipedia.