What pre-tax cash-on-cash captures
The standard formula — annual cash flow ÷ cash invested — uses pre-tax cash flow. It ignores both the tax you owe on net rental income and the tax savings from depreciation. Pre-tax cash-on-cash is fast and useful for comparing deals, but understates the true return for taxpayers who can put depreciation deductions to use.
How depreciation improves after-tax return
Depreciation is a non-cash deduction that reduces taxable income. Even when a property generates positive cash flow, depreciation often creates a paper loss that lowers your tax bill. Those tax savings are real dollars. After-tax cash-on-cash adds those savings back to the numerator, giving a truer picture of what the investment earns.
When the difference is largest
The gap between pre-tax and after-tax return is widest when depreciation is large relative to cash flow (high-basis property, early years in ownership), when you're in a higher tax bracket, and when passive activity rules allow you to use the deductions. The gap narrows when passive losses are suspended or your bracket is low.
Frequently asked questions
Should I use pre-tax or after-tax cash-on-cash?
Pre-tax is the standard for quick comparisons. After-tax is more accurate for a full investment analysis, especially if you can use depreciation deductions.
How does depreciation affect after-tax return?
Depreciation creates a paper loss that offsets rental income, reducing your tax bill — effectively adding to your after-tax cash flow.
Sources
Educational information and estimates only. Not tax advice. Tax rules change and vary by situation; consult a qualified tax professional before acting.