Net Income—What Do You Really Take Home?By
The best way to maximize your investments is to understand what constitutes true income. This means that you need to examine both the gross income (all incoming dollars before expenses) and net income (the money you have left after paying expenses). Knowing what you actually earn can help you determine what expenses could be lessened to help increase your net income.
Understanding The Balance Sheet—Tips from the IRS
When you prepare your tax filings, you need to include all gross income from rent. The IRS defines rental income as any payment you receive for use or occupation of the property. The IRS will allow you to deduct expenses in the same year you pay them.
In preparing your filings, you need to report income for the year you actually or constructively receive it. This includes advance rents (any amount received before the period it is due), security deposits (only if you plan to keep the money because the tenant fails to properly hold up the lease), and expenses paid by the tenant (if the tenant pays any expenses).
What Are My Expenses?
Rental expenses include a wide variety of payments you make as owner to maintain the property. These can include repairs, vacancies, debt service, insurance, accounting, janitorial services or management.
The common definitions of these expenses are:
1. Repairs refer to any part of the property that you have physically changed either by necessity or cosmetic choice. They can include fixing a broken water heater, repairing broken windows or changing the locks for enhanced security.
2. Vacancies are the expenses incurred by the owner from not having an income from a unit because it is unoccupied by a paying tenant. For example, if an owner has a four-unit apartment building with each unit renting for $500 per month, the owner would receive $2,000 a month if the building were fully occupied. If only three units are occupied, then the owner receives $1,500 per month leaving a $500 per month expense.
3. Debt service refers to the series of interest and principal payments required on an obligation over a set period of time.
4. Insurance refers to the promise made by an insurer of compensation for specific potential future losses in exchange for payment. Insurance is designed to protect the financial well being of the insured.
5. Accounting refers to any payments made to a person or firm to prepare financial statements, create and maintain billing systems or otherwise perform general bookkeeping duties.
6. Management and Janitorial services refer to any payments made to staff to manage or clean the units.
What am I left with?
The remainder of the income after paying your expenses is your net income. Many real estate experts recommend at least a 75/25 net to gross income ratio. If you are receiving less net income, examine your expenses and programs. Now may be a good time to look at technologies to help cut costs and streamline your income process.