The $669 rental that actually loses $173 a month

Quick answer: Rent minus the mortgage isn't cash flow. Subtract taxes, insurance, empty months, repairs and a reserve for big-ticket items, and many houses bought at today's rates lose money every month. This is general education, not advice.

Here's the napkin version. You find a $250,000 house that rents for $2,000 a month. You put 20 percent down, borrow $200,000 at 7 percent over 30 years, and the principal-and-interest payment comes to about $1,331. Rent minus payment: $669 a month. Somebody at a barbecue tells you the tenant pays it off for you.

Now do it like a grown-up.

(Every number below is an assumption for illustration. Your rent, rate, tax bill and house will differ. Swap in yours before you do anything.)

The monthly math, line by line

• Rent: $2,000
• Mortgage payment (principal and interest): $1,331
• Property taxes at 1.2 percent of value: $250
• Landlord insurance, about $1,500 a year: $125

That leaves $294. Already less than half the napkin number, and we haven't touched the house yet.

• Vacancy, one empty month a year: $167
• Repairs and upkeep, about 1 percent of the home's value a year: $200
• Reserve for the roof, water heater and HVAC: $100

Total after all of it: negative $173 a month, about $2,000 a year out of your pocket.

That's not a worst case. One empty month a year is modest, and the repair figure is a common rule of thumb, not a guarantee. A bad winter, a turnover that needs new carpet and paint, or a tenant who stops paying will make it uglier.

Where the money actually comes from

A rental pays you in three ways, and only one of them shows up in your checking account.

Cash flow. In our example, negative $173 a month.

Principal paydown. Each payment chips away at the loan. In year one that's about $2,000 on this mortgage. It's real, but you can't spend it until you sell or refinance.

Appreciation. Say the house gains 3 percent. That's $7,500. Say it doesn't. Nobody can promise you a number here, and prices can fall as easily as rise.

Your cash in is the $50,000 down payment plus closing costs, call it $6,000. On $56,000, the first year looks like this: roughly break even from cash flow and principal, plus whatever the market does. If it goes your way, that's a decent return. If it doesn't, you've tied up $56,000 for nothing.

So be honest about what you're doing. At these numbers it isn't a rental business. It's a bet on home prices, with a tenant covering most of your carrying costs.

What the tax return does (and doesn't do)

Landlords get real deductions: mortgage interest, property taxes, insurance, repairs, and depreciation. Residential rental buildings are depreciated over 27.5 years. Only the building counts, not the land.

Say $200,000 of the price is building. That's about $7,300 a year in depreciation.

Collected rent comes to $22,000 after the empty month. Interest (about $13,900), taxes, insurance and repairs total about $20,800. Before depreciation you "earned" $1,200. After it, the return shows a paper loss of around $6,000.

Two catches.

First, a paper loss isn't cash. You're still writing checks. Second, passive loss rules limit how much of that loss you can use against your paycheck. There's a $25,000 allowance for landlords who actively participate, and it phases out between $100,000 and $150,000 of modified adjusted gross income. Above that, losses generally get carried forward. If you want to see how your wages already get taxed, start with your payslip and where the money went.

And when you sell, the IRS wants some of the depreciation back. It's called recapture, and the rate can reach 25 percent. A CPA who handles rentals can model all of this in an hour. Pay for the hour before you buy, not after.

Three things that change the answer

The price-to-rent ratio. Rules of thumb like "monthly rent should be 1 percent of the price" exist because they screen out houses like our example (0.8 percent) quickly. They're a filter, not a verdict. Always run the full line-by-line.

More down, or a lower rate. Put 30 percent down and the payment shrinks. Investment loans commonly require 15 to 25 percent down anyway, with rates a bit above what you'd pay on a home you live in. Ask a lender for real numbers on an investment property, not a primary residence.

Your own labor. Mowing, painting and fixing a running toilet yourself keeps repair money in your pocket. But your Saturdays have a price. A hired property manager typically takes a percentage of rent each month, so price that in if you're not nearby.

Before you sign anything

Don't buy a rental with your emergency money. You need your household cushion untouched and a separate cash reserve for the property. Your emergency fund is insurance, not savings, and a furnace that dies in January is exactly what it's for.

Pay off high-interest debt first. Paying down a 22 percent credit card is a guaranteed return. A rental offers a hoped-for one. The order matters, and the arithmetic on paying off debt lays it out.

Got a lump sum from a bonus, a sale or an inheritance? A down payment is one use, and a tempting one. Read what to do with a lump sum before it quietly disappears first.

Then run the worksheet:

1. Write down rent, payment, taxes, insurance, vacancy, repairs and reserve. Use your real quotes.
2. Add your actual cash in: down payment and closing costs.
3. Run it again with rent 10 percent lower and one more empty month.
4. If it only works when everything goes right, it doesn't work.
5. Ask a CPA, a lender and an attorney about your specific situation.

The part the spreadsheet can't price

A tenant is a family living in your property. They deserve a safe, dry, working home, and fixes done promptly. Leave the place better than you found it every time you walk through the door. That's the servant half of being a landlord.

The other half is a backbone. Screen applicants. Put everything in a written lease. Charge the late fee you wrote down. A landlord who can't say "the rent is due on the first" will end up carrying somebody else's problems on his own mortgage.

Do both, and do the math first. The house doesn't care how nice you are, but the bank sure doesn't either.