The listing says the duplex earns a 7.3% cap rate. The lender's underwriter says it covers its mortgage with room to spare. In April your accountant says it lost $2,850. All three are reading the same building over the same twelve months, and none of them is wrong, because each one is quoting a different number: net operating income, pre-tax cash flow, and taxable income.
Most of the confusion around “is this property making money” comes from swapping those three numbers mid-sentence. NOI asks what the building itself earns, before anyone's mortgage or tax bracket enters the room. Cash flow asks what lands in your account after the lender is paid. Taxable income asks what the IRS considers profit once its rules about interest, principal, and depreciation are applied. Same rent on top, three different stacks of subtractions underneath. This guide runs one hypothetical duplex through all three calculations, line by line.
The duplex and its year
Say you buy a duplex for $330,000. The facts of the deal and of the first full year:
- Cash in: $82,500 down (25%) plus about $7,500 in closing costs, so $90,000 of cash enters the deal.
- Loan: $247,500 at 7% over 30 years, which is principal and interest of $1,647 a month, $19,764 a year.
- Rents: two units at $1,500 a month each, $36,000 a year if every month gets paid.
- Vacancy: one turnover cost $1,800 in lost rent, almost exactly the 5% a careful underwriter would have assumed, so rent collected was $34,200.
- Operating expenses: property taxes $4,300, insurance $1,800, water, sewer, and trash $1,400, lawn care and snow removal $900, routine repairs and maintenance $1,800. Total: $10,200.
Every number below comes from this one set of facts. The differences are entirely in what each calculation chooses to subtract.
NOI: what the building earns
NOI = effective gross income − operating expenses
For our duplex: $34,200 − $10,200 = $24,000 of net operating income. Divide by the $330,000 price and you get the 7.3% cap rate from the listing; you can run your own deal through the cap rate calculator.
Notice everything NOI ignores. No mortgage, because financing is the owner's choice, not the building's earning power; the same duplex bought with cash or with 25% down produces the same NOI. No capital expenditures, because by convention roofs and furnaces sit below the line, a convention with consequences worked through in CapEx vs OpEx. No depreciation and no income taxes either. NOI exists so that appraisers, lenders, and buyers can compare buildings across different owners, which is exactly why your lender divides it by annual debt service to get a debt service coverage ratio ($24,000 ÷ $19,764 is about 1.21 here, a pass at most banks). NOI is the building's number. The mortgage is yours.
Cash flow: what is left after the lender
pre-tax cash flow = NOI − annual debt service
For our duplex: $24,000 − $19,764 = $4,236 a year, or $353 a month. That is the number your checking account experiences, and it is the first place the duplex stops looking impressive. A 7.3% cap rate became $353 a month the moment the mortgage showed up.
Two honest adjustments make it thinner. First, that figure holds no reserve for capital costs, and the roof does not stop aging because NOI ignores it; hold back even a modest $200 a month and the duplex clears $153 a month, about $76 per door. Second, measured against the $90,000 you put in, $4,236 is a 4.7% cash-on-cash return, a long way from the cap rate on the listing. The full math, and what counts as a good number, is worked out in the cash-on-cash guide and the cash-on-cash calculator. You cannot deposit a cap rate.
Taxable income: what Schedule E says you made
The IRS starts from the same $34,200 of rents received, then applies its own subtractions, which match neither list above:
- Operating expenses, $10,200: all currently deductible, same as they were for NOI.
- Mortgage interest, $17,250: in year one, $17,250 of the $19,764 you paid the lender is interest, and only the interest is deductible. The other $2,514 is principal: real cash out the door, zero deduction, because the IRS treats it as you buying equity from your lender.
- Depreciation, $9,600: the building's basis is $264,000 ($330,000 less $66,000 of land, which never depreciates), recovered straight-line over 27.5 years. That is $9,600 for a full year of service, prorated by the mid-month convention in year one. The mechanics live in the depreciation guide.
Run the column: $34,200 − $10,200 − $17,250 − $9,600 = −$2,850. The duplex that produced $24,000 of NOI and put $4,236 of cash in your pocket reports a $2,850 loss on Schedule E. Whether that loss offsets your other income this year depends on the passive activity rules and your income level, which is a conversation for your CPA. IRS Publication 527 is the governing reference for what residential landlords deduct and depreciate. Depreciation is the only deduction that never asks you to write a check.
Where each dollar shows up, and where it hides
Set the three results side by side: $24,000 of NOI, $4,236 of pre-tax cash flow, a $2,850 taxable loss. One building, one year, no contradiction. Each line item reports to some numbers and not others:
- Vacancy and operating expenses hit all three numbers the same way. These are the only items the three calculations agree on.
- Mortgage interest skips NOI, drains cash flow, and deducts on Schedule E.
- Principal paydown skips NOI, drains cash flow, and never deducts. It is the quiet reason cash flow understates your total return: $2,514 of this year's payments became equity.
- Capital expenditures skip NOI by convention, drain cash flow the day you pay for them, and reach the tax return only over years, as depreciation.
- Depreciation skips NOI, costs no cash this year, and deducts $9,600.
Read down that list and the duplex's split personality stops being mysterious. Strong NOI with thin cash flow means the financing is heavy, not that the building is bad. Positive cash flow with a paper loss means depreciation is doing its job. Each number is honest about its own question and silent about the other two.
Which number to trust, and how to keep them straight
Use NOI when you are pricing or comparing: it is the number that survives a change of owner, which is why cap rates and appraisals are built on it. Use cash flow when you are deciding whether you can hold the property: a bad furnace year is survived with cash, not with cap rate. Use taxable income only in April, and never let it near a purchase decision, because a number that treats a $9,600 non-cash deduction as an expense is not trying to tell you what the building earns.
The practical problem is that one checkbook has to produce all three, and that is a categorization discipline, not a math problem: mortgage payments split into interest and principal, capital work kept out of the repairs column, every expense tagged once, the same way, every month. That discipline is the spine of rental property accounting, and it is where spreadsheets quietly fail, usually by booking the whole $1,647 mortgage payment as an expense, which understates NOI and overstates your deductions in a single keystroke.
I self-manage my own small portfolio from two time zones away, and I built rents.ai because my spreadsheet kept dropping exactly those splits. It computes NOI, cash flow, cap rate, and a Schedule E-categorized view from the rent roll and expense ledger you already keep there, and it divides each mortgage payment into interest, principal, and escrow so principal stays in your cash flow but out of NOI and the tax view. The honest limit: it does not connect to your bank, so you record payments and expenses yourself or import a CSV, and everything its tax view produces is an estimate to organize your year for your CPA, not a filing.
Whatever you use, close the month while the receipts are fresh. The three numbers only stay trustworthy if the ledger underneath them does.
The duplex above is hypothetical and the figures are rounded estimates meant to show how the three calculations relate, and to organize your own numbers before they go to your CPA. None of it is tax advice; depreciation, passive loss treatment, and what counts as deductible in your situation are calls your CPA should confirm.