Analyzing Rental Property ROI: How to Calculate Total Return

To calculate total return on a rental, add four things for the period you are measuring: cash flow, the mortgage principal paid down, the change in the property's value, and the tax the property saves or costs you. Divide that total by the cash you put in to get ROI. Cap rate ignores the loan and cash-on-cash return counts only cash flow, so total ROI is the only one of the three that measures the whole result, though appreciation and the tax at sale stay estimates until you sell.

The four parts of total return

1. Cash flow before taxes: rent at full occupancy minus a vacancy allowance, operating expenses, and the full mortgage payment. How to calculate rental property cash flow builds it line by line.
2. Principal paydown: the part of each payment that reduces the loan. On a $180,000, 30-year loan at 7.75%, it is $1,580 in year 1 and $2,152 in year 5. It is not deductible, and you get it back only when you sell or refinance.
3. Appreciation: the change in value. The Federal Housing Finance Agency's house price index rose 2.1% nationally from the second quarter of 2025 to the second quarter of 2026. Among the 100 largest metro areas, the change ranged from a 7.7% gain in Elgin, Illinois, to a 3.7% drop in Everett, Washington. Use your own metro's history, and also run the numbers at 0%.
4. Tax effects: depreciation lets you deduct the building's cost, but not the land's, over 27.5 years, which lowers the tax on rental income without costing cash. If deductions exceed rental income, you can use up to $25,000 of the loss against other income if you actively participate (for example, by approving tenants and setting rents), own at least 10% of the property, and have modified adjusted gross income (MAGI), your adjusted gross income figured without the rental loss and a few other items, of $100,000 or less. The allowance shrinks by 50 cents for each dollar of MAGI above $100,000 and is gone at $150,000. A loss you cannot use carries forward, and any unused amount becomes deductible in full when you sell your entire interest in a taxable sale to an unrelated buyer. Depreciation on rental property shows how to figure the yearly deduction.

Year 1: a cash purchase versus a financed purchase

A house costs $240,000 and produces $14,400 a year of net operating income (NOI), rent collected minus operating expenses before any loan payment, which is a 6.0% cap rate. The purchase adds $4,000 of title, recording, and transfer costs, which become part of the property's cost for tax purposes. The land is 20% of the total, so depreciation is $244,000 x 80% / 27.5 = $7,098 a year. A loan adds $3,000 of points, upfront fees paid to the lender for the loan. Points are not part of the property's cost; they are deducted over the loan's 30-year term, $100 a year, and the rest is deducted when the loan is paid off. The example assumes NOI stays at $14,400, values rise 2% a year, and a 22% tax rate.

For the financed column, the taxable result is $14,400 of NOI minus $13,895 of year-1 interest, $7,098 of depreciation, and $100 of points, a $6,693 loss. In the cash column, depreciation cuts the tax bill by $1,562 a year compared with paying tax on the full $14,400. This NOI includes no capital reserve. If yours does, add the reserve back before figuring tax: money set aside is not deductible, and a replacement roof or furnace is generally an improvement you depreciate rather than deduct in the year you pay for it.

At 2% appreciation the two purchases tie on pre-tax ROI. The loan's payments come to 8.6% of the amount borrowed each year, while the house earns 6.0% before financing, so the financed purchase loses cash every month and does better only if values rise faster than about 2% a year. With no appreciation, it returns 0.8% against 5.9% for the cash purchase.

ROI at sale: the whole holding period

Year-1 ROI counts appreciation you have not collected and ignores the cost of selling and the tax on the sale. Here is the financed purchase sold after five years:

1. Sale price after five years of 2% appreciation: $264,979.
2. Selling costs, assumed at 6% for commissions, transfer taxes, and closing fees (get local quotes): $15,899, leaving $249,080.
3. Loan payoff: $170,726, leaving $78,354 of cash from the sale.
4. Tax on the sale: your adjusted basis, the cost minus the depreciation taken, is $244,000 minus $35,490 (five full years of $7,098; the first and last years are actually prorated by month), or $208,510. The gain is $249,080 minus $208,510, or $40,570. The part equal to the depreciation, $35,490, is taxed at no more than 25%; at the 22% rate used here, that is $7,808. The other $5,080 is a long-term capital gain (property held more than a year), taxed at 0%, 15%, or 20% depending on your income ($762 at 15%). Total tax: $8,570.
5. After-tax cash from the sale: $78,354 minus $8,570, or $69,784.
6. Add the years of ownership: five years of cash flow (5 x -$1,075 = -$5,375), the tax saved by deducting each year's loss ($7,060 over five years, falling as the interest share of the payment shrinks), and $550 saved by deducting the last $2,500 of points when the loan is paid off.

Total profit is $69,784 minus $5,375 plus $7,060 plus $550, minus the $67,000 you invested, or $5,019. That is a 7.5% return over five years, or about 1.5% a year as an internal rate of return (IRR), the annual rate that accounts for when each dollar went in and came back. A spreadsheet's IRR function calculates it from the yearly amounts. If your income was too high to deduct the yearly losses, those losses carry forward and become deductible in the year of sale instead.

The five-year result depends heavily on the appreciation assumption (after-tax annual return as IRR, other assumptions unchanged):

For comparison, the 10-year Treasury yield was 4.96% on October 22, 2026, or about 3.9% after federal income tax at 22%. Treasury interest is exempt from state income tax, while these rental returns count federal tax only and would be lower in a state that taxes rental income and gains. If your adjusted gross income is above $200,000 (single) or $250,000 (married filing jointly), the 3.8% net investment income tax also applies to rental profit and the gain on a sale, charged on the smaller of that investment income or your income above the threshold.

How total ROI differs from cap rate and cash-on-cash return

Use cap rate to compare buildings' prices with their income before financing and cash-on-cash return to see the yearly cash on the money you put in. Appreciation vs cash flow covers choosing between properties that pay mostly now and those that pay mostly at sale, and how to buy your first rental property covers the purchase steps.