How is taxable income from an investment property estimated?

Taxable income from an investment property is estimated by taking the net income generated by the property and subtracting both interest payments and depreciation. This approach reflects the real economic impact on the property owner’s income because it accounts for the costs associated with financing and the wear and tear on the property over time.

Net income represents the cash flow from the property after operating expenses have been deducted, providing a clear picture of profitability. However, to arrive at the taxable income, it is essential to also consider how much of that net income is not actually realized in cash terms due to loan interest costs and the non-cash expense of depreciation.

Interest expenses reduce the income that investors ultimately pay taxes on since they are considered a cost of securing financing for the property. Depreciation, on the other hand, allows property owners to account for the reduction in value of the physical property over time, providing a tax shield that further reduces taxable income.

This calculation is fundamental for investors to understand how much they would actually pay in taxes on their investment gains, accounting for both the operational profitability of their property and the tax relief provided by interest and depreciation.