You inherit a haunted house from a long-lost uncle you didn't know you had. You decide to rent it out to earn a little cash. Other similar homes in that area are renting for $2,500 a month. So that means your annual income from the property will be $30,000, right? After all, that's $2,500 a month times 12 months in a year...gives you $30,000 a year.
Kind of. That figure is called your gross potential income. It's the hypothetical total you'd receive if everything goes perfectly. But everything rarely goes perfectly. Thus, effective gross income becomes a more realistic figure.
You can start with gross potential income, but the "effective" part becomes key in a real-life scenario. There are other factors to take into account.
Some of these are good. A property can generate other income besides rent. Your uncle's house has a coin-operated washing machine in the basement and pay toilets in all the bathrooms. Extra money for you. Those figures get added in when you calculate the effective gross income.
However, some factors take away from the final total. For instance, you might have a hard time finding a tenant. It's a haunted house, after all (and one with pay toilets). Having the house vacant while you look for a renter will take away from your income.
Similarly, you have to take into account the fact that some renters don't always pay on time, or at all. If they don't, that cuts into your income as well.
Effective gross income takes this into account. Start with your gross income, add in the additional income, and subtract for the vacancy and credit allowances. It gives you a more realistic figure about what to expect in terms of annual income.
Related or Semi-related Video
Finance: Why Do Taxes Exist?138 Views
Why do taxes exist and notice we're saying that with a kind of a whiny tone
alright well someone has to pay for this and this and this and this yep there are [Hand pointing to a road, a school, a plane and a park]
a bunch of different types of taxes in each of them carries a different purpose
yeah Road taxes get paid in large part out of
the gasoline you buy you got to pay for the building and maintaining of potholes [Car drives into a pothole]
right and that makes sense if you drive a car you use the roads more so you
should pay more for its use that's like a use tax get it cleverly named if for [Price for federal tax per gallon and state tax per gallon]
when you own a home you'll pay real estate tax and for the most part that
tax is designated to pay schools all right well but like everything [Hand holding money from real estate tax to pay for schools]
government related nothing is simple in America the federal government has kind
of a matching program for schools where they pay for a portion of the education
cost based on various factors and you don't want us to get into that in the [complicated equation on chalkboard]
video all right well the largest taxes most people pay are income taxes and
those generally pay for the government to you know govern us if a couple made a
hundred grand jointly in California last year they'd pay around thirty [A couple stood together in their home]
thirty-five grand in taxes that money covers things like shiny new airplanes
to force the mean countries to play nice in the schoolyard it covers repairs to
crumbling bridges and tunnels across the country it covers public protective [Bridges crumbling]
services like police and fire department people
it covers libraries and public parks, well don't feel like you're getting your
money's worth these days if you're ever not feeling that you can always move to [Woman chased from a park by a tiger]
the Ukraine discounts on citizenship they're everywhere
Up Next
What are the types of income tax? Federal income tax. State income tax. Real estate tax. Value Added Tax (VAT). Some tax is progressive, some tax i...
What is the difference between progressive and regressive taxes (flat tax vs. marginal tax)? In the most basic sense, progressive taxes affect the...
What is the difference between federal and state taxes? Federal taxes: the whole country. Taxes for national defense, interstate roadways, national...