What is Gross Income?
REtipster provides real estate guidance — not tax or investment advice.
This article should not be interpreted as financial advice. Always seek the help of a licensed financial professional before taking action.
Gross Income Explained
For individuals, gross income is the total of one’s wages, dividends, interest, alimony, rental income, and any other sources of income before any expenses are deducted. It is reported on their tax return before certain deductions and exemptions to determine adjusted gross income.
For businesses, gross income is synonymous with gross profit. Business gross income is defined as gross revenue minus the cost of goods sold (COGS) and is reported on the tax return and the income statement.
Why is Gross Income Important?
Individual gross income is a baseline metric for lenders and others, such as landlords, who need to assess creditworthiness and the borrower’s ability to repay their loan.
It’s also the starting point for individual tax filings. Deductions such as retirement plan and HSA contributions are subtracted from individual gross income in above-the-line calculations to arrive at adjusted gross income or AGI. Standard or itemized deductions are then subtracted from the adjusted gross income to arrive at taxable income.
In a business setting, gross income is basically a metric of profitability. Remember, a business’ gross income reflects its gross revenue minus cost of goods sold; other expenses such as taxes and administrative costs are subtracted from gross income to arrive at net profit.
How is Gross Income Calculated?
For individuals, gross income is calculated by simply adding all sources of income before subtracting any expenses such as taxes, insurance, and retirement contributions.
The formula for calculating business gross income is:
Gross revenue – Cost of goods sold (COGS) = Business Gross Income
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Gross Income vs. Effective Gross Income
Effective gross income (EGI) is a factor commonly used in determining the value and potential cash flow of a rental property.
The calculation for effective gross income is:
Gross Potential Rent + Other Income – Vacancy Costs – Credit Loss = Effective Gross Income
Gross Potential Rent (GPR) is the amount of rental income a property would generate if all units were rented. For example, a fourplex in which each unit rented for $1,500 a month would have a GPR of $48,000.
Other Income includes items such as parking and storage rental, laundry machines, and late fees.
Vacancy Costs are typically calculated as a percentage; and it represents the percentage of time a rental property or rental unit sits empty. Vacancy rates vary by location and market.
Credit Losses occur when a tenant doesn’t pay full rent on time and it also includes the costs to evict a tenant.
Other factors can affect effective gross income. For example, downtime, when units are vacant because the property is being renovated or rehabbed, would depress the effective gross income. Similarly, turnover costs in commercial property are sometimes deducted from effective gross income, although some accountants include them as operating expenses in the general ledger.
Examples of Gross Income
The following examples help explain gross income in individual and business situations as well as effective gross income in a real estate setting:
Individual Gross Income: Vincent earns $88,000 per year in salary. He generates $22,000 of income from his rental property and $2,500 of interest income per year. His gross income is $112,500. ($88,000 + $22,000 + $2,500 = $112,500)
Business Gross Income: Midwestern Widgets generated $20 million in gross revenue. The company’s cost of goods sold was $7.5 million. Midwest Widgets has a business gross income or gross profit of $12.5 million. ($20 million – $7.5 million = $12.5 million)
Effective Gross Income: Susan’s duplex has gross potential rent of $60,000 per year and $1,000 per year in parking permits. Her vacancy and credit loss costs are $5,000 per year. The duplex has an effective gross income of $56,000. ($60,000 + $1,000 – $5,000 = $56,000)
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