The short answer
Internal rate of return (IRR) is the discount rate at which the present value of every cash flow from an investment, money in and money out, nets to zero. It is the same math the Treasury regulations use for a bond's yield to maturity, applied to rents and a sale. Because it weights each dollar by when it arrives, a delayed sale or a lower exit price can move IRR more than years of steady income.
At a glance
| Definition | The rate that makes the net present value of all cash flows equal zero |
|---|---|
| Inputs | Equity invested, each distribution and the net sale proceeds, with their dates |
| Net versus gross | Net IRR is after all fees, expenses and performance compensation; gross is before |
| Projections | A projected IRR is an assumption about rents, exit price and timing, not a result |
Federal rules define IRR as the rate that zeroes net present value.
The SEC's 2023 private fund adviser rules defined internal rate of return as the discount rate that causes the net present value of all cash flows throughout the life of the fund to equal zero, and net IRR as IRR after all fees, expenses and performance-based compensation (88 FR 63206). A federal court vacated those rules effective June 5, 2024, and the SEC removed them from the regulations (89 FR 91252), but the definition remains the standard statement of the math.
The tax version is older. Reg. section 1.1272-1(b)(1)(i) defines a debt instrument's yield to maturity as the discount rate that, applied to all payments, produces a present value equal to the issue price, and requires it to be constant over the term. An IRR is that yield for an investment whose payments are rents and a sale price instead of coupons.
A worked example shows a delayed sale lowering IRR while total cash rises.
Hypothetical: you invest $1,000,000 and receive $50,000 at the end of each year for seven years, then $1,250,000 from the sale at the end of year seven. Total cash back is $1,600,000 and the IRR is about 7.8%.
If the sale slips to year nine at the same price, with two more years of $50,000, you collect $1,700,000 but the IRR falls to about 7.1%. If instead the property sells on time for $1,000,000, the IRR is 5.0%, exactly the distribution rate, because the capital came back whole. The amounts are rounded to keep the example readable; your own facts will differ.
It bites when a projected IRR is treated as a forecast or compared across bases.
A large part of a projected IRR can rest on the assumed exit price and date, which no one knows at purchase. FINRA Rule 2210(d)(1)(F) bars member firm communications from predicting or projecting performance, apart from narrow exceptions, and the SEC's marketing rule treats targeted or projected returns as hypothetical performance and requires net performance alongside any gross figure. Read a DST projection in the memorandum's assumptions, see reading a DST memorandum and Form D.
Compare like with like. Pre-tax IRR ignores the tax you defer with an exchange; an after-tax IRR models the tax on income and on the sale, so a 1031 that defers the gain can raise it by keeping more equity working. Pair IRR with the equity multiple, which shows how much cash comes back, and with DST yield versus total return. For a model of selling versus exchanging, see the sell versus 1031 numbers.
Related questions
Is a higher IRR always better?
Not on its own. A short deal can show a high IRR on little profit, while a longer one earns more dollars at a lower rate, which is why IRR is read with the equity multiple.
What is the difference between IRR and a DST's distribution rate?
The distribution rate is one year's cash divided by equity, a cash-on-cash measure. IRR covers the whole hold, including the sale, and weights each payment by its timing.
Can IRR be calculated by hand?
Rarely. For most patterns of cash flow there is no closed formula, so spreadsheets solve for the rate by trial and iteration until net present value reaches zero.
Sources
Checked against these publications on September 30, 2026. Rules and figures change; confirm the current version with your CPA or attorney before you act. This page is general information, not tax or legal advice.
- SEC, Private Fund Advisers; Documentation of Registered Investment Adviser Compliance Reviews, 88 FR 63206 (September 14, 2023)
- SEC, Private Fund Advisers; technical amendments reflecting vacatur, 89 FR 91252 (November 19, 2024)
- 26 CFR 1.1272-1, Current inclusion of OID in income
- 17 CFR 275.206(4)-1, Investment adviser marketing
- FINRA Rule 2210, Communications with the Public