L 6: Real Estate Investment & Taxation

Single individuals may exclude a gain up to ___.

$250,000

Married couples may exclude a gain up to ___.

$500,000

To offset disparity in equity or value in property, investors give ___.

boot

All of the following relate to limited liability companies EXCEPT ___. a. members b. limited liability c. articles of incorporation d. articles of organization

c. articles of incorporation (Articles of incorporation are used to for corporation. The other choices are related to limited liability companies.)

When NOI is based on hypothetical future estimates in order to assist in decision making, it is known as a(n) ___. a. financial statement b. market analysis c. operating budget d. proforma statement

d. preforms statement (A proforma statement uses hypothetical data to look into the future to assist in decision making such as whether or not to purchase property.

The purpose of the 1031 exchange is to ___.

defer taxes on capital gains

Exchanges must be completed within ___.

180 days

A homeowner is eligible for the capital gains exclusion if he lived in the home as his primary residence for ___ of the last ___ years.

2/5

Which element does NOT figure into the equation to find net operating income? a. debt service b. effective gross income c. expenses d. vacancy losses

To find the NOI: first, subtract vacancy losses from gross income to get effective gross income. From that, subtract expenses to find NOI. Debt service is not used to find NOI.)

Which of the following would be considered a security? a. single-family homes in an investment pool b. more than six separate lots for sale c. land owned by a corporation d. single-family home listed by an LLC

a single-family homes in an investment pool (An investment pool, even for real property, is considered a security, as it allows a group of investors to combine their money to make larger investments.)

Clark and Lois bought their primary residence in 2001 for $300,000. They recently sold it for $500,000. On what amount will they owe capital gains? a. $0 b. $200,000 c. $300,000 d. $500,000

a. $0 (Their gain on the sale of the property is $200,000, which is well within the $500,000 exemption. So, they will owe no capital gains tax.)

Gina purchased her home 10 years ago for $165,000. In her neighborhood, home values have been appreciating at a rate of 2.5% per year. What can Gina expect her home to be worth today? a. $206,250 b. $211,214 c. $219,615 d. $241,250

a. $206,250 (2.5%x10years=25%. $165,000x0.25=$41,250. $165,000+$41,250=$206,250.)

Helen bought a small office building for $50,000. She sold it 10 years later for $48,000. What is her percent of loss? a. 4% b. 4.2$ c. 9.6% d. 10.4%

a. 4% (She lost $2,000 on the sale. To determine the loss, divide what she lost by what it cost: $2,000/$50,000=0.04 or 4%)

In order to avoid paying income tax, a REIT must earn ___% of its income from real estate and distribute _)% of its taxable income to its beneficiaries. a. 75/90 b. 85/90 c. 50/75 d. 70/90

a. 75/90 (A REIT must earn 75% of its income from real estate and distribute 90% of its taxable income to its beneficiaries.)

An investor buys a duplex for $208,000. Each unit rents for $950 a month. The property has a 5% vacancy and annual operating costs of $4,200. What is the capitalization rate on this property? a. 8.4% b. 8.6% c. 10.9% d. 11.9%

a. 8.4% (First, determine the potential gross income: $950x2x12 months=$22,800. Determine the vacancy loss: $22,800z0.05=$1,140. Find the effective gross income: $22,800-$1,140=$21,660. Find the NOI: $21,660-$4,200=$17,460. Finally, use the IRV formula to find the cap rate: $17,460 (Income)/$208,000 (Value)=0.0839 (rate) or 8.4%.)

The income and losses from each of these business entities is passed through to the individual EXCEPT for a ___. a. C corporation b. general partnership c. limited partnership d. sole proprietorship

a. C corporation (Of these, only profits from a C corporation could lead to double-taxation. With the other entities, income and losses of the organization are passed through to the individual.)

The original cost of the property plus gains, minus losses from taxes, and considering any boot is know as the ___. a. adjusted basis b. basis c. capital gains d. equity

a. adjusted basis (The adjusted basis is the basis (original cost) of property, with the gains and losses from taxes and boot calculated in.)

Net operating income minus debt service is equal to ___. a. cash flow b. expenses c. leverage d. rate of return

a. cash flow (Net operating income minus debt service is equal to cash flow.)

A borrower is required to put 10% down for the purchase of a property. The 10% down would be considered ___. a. equity b. boot c. tax shelter d. leverage

a. equity (Whatever a borrower makes as a down payment can be considered their initial equity in the property.)

Doctors Dora, Cora, and Flora pool their resources to purchase a vacant lot in their neighborhood. Their plan is to look for a company willing to buy the property and build a market with fresh produce for their underserved area. This could best be described as a ___. a. joint venture b. limited partnership c. real estate investment trust d. syndicate

a. joint venture (A joint venture is an arrangement in which tow or more individuals ore companies pool resources in order to engage in one project or a series of projects but not as an ongoing business concern.)

Cash-on-cash return is ___. a. money received on equity b. money received on loan c. money received on taxable income d. money received on taxable profit

a. money received on equity (Cash-on-cash return is the bottom line of any investment, expressed as a percentage. It is founded by dividing the investment's cash flow by the down payment and settlement costs, in other words, by the equity.)

Residential rental property can be depreciated over ___ years. a. 15 b. 27 1/2 c. 31 1/2 d. 39

b 27 1/2 (The time requirement to depreciate residential rental property is 27 1/2 years.)

The operating statement on Ken's rental property shows an effective gross income of $48,750 and a NOI of $28,000. He pays $2,900 a year for insurance, $7,000 a year for property taxes, and $15,600 a year on his mortgage. What is the before tax cash flow? a. $2,500 b. $12,400 c. $18,100 d. $23,250

b. $12,400 (Cash flow is simply NOI minus debt service: $28,000-$15,600=$12,400. The insurance and property taxes would have been deducted from the effective gross income as operating expenses to arrive at the NOI.)

If a house is currently worth $190,000 and has depreciated 12% since it was purchased, what was the original value? a. $212,800 b. $215,909 c. $310,000 d. $357, 200

b. $215,909 (Step 1: 100%-12%=88%. Step 2:$190,000/0.88=$215,909.)

Brock is selling an apartment building and wants to do a like-kind exchange for an office building. What is his deadline for identifying the office property he wants to purchase? a. 30 days b. 45 days c. 120 days d. 180 days

b. 45 days (He must identify the property he will purchase within 45 days of the sale fo the apartment building.)

A homeowner bought a house for $278,000. She sold it nine years later for $264,000. What is her percent of loss? a. 3.9% b. 5.0% c. 5.3% d. 9.5%

b. 5.0% (Remember "what she lost divide by what it cost." She lost $14,000 (which is $278,000-$264,000=$14,000), so $14,000/$278,000=0.05 or 5% loss)

Jim buys a four-unit apartment building. He put 10% down on a purchase price of $500,000. Based on his financing terms, the monthly principal and interest is approximately $2,700. The NOI is $35,000 annually. What is the cash-on-cash return? a. 4.4% b. 5.2% c. 6.5% d. 8.8%

b. 5.2% (Deduct annual debt service of $32,400 ($2,700 x12) from the $35,000 NOI to find a cash flow of $2,600. Divide that by his investment (down payment) of $50,000 (10% down) to find the cash-on-cash return of 5.2%)

Jenny paid $245,000 for a small office building. Her net operating income is $35,750 and her cash flow is $18,650. What is her cash-on-cash return? a. 7.0% b. 7.6% c. 8.9% d. 14.6%

b. 7.6% (Divide the cash flow by the purchase cost: $18.650/$245,000=0.076 or 7.6%)

Gavin bought an investment property for $420,000, making a $80,000 down payment. At the end of one year, his balance sheet showed a profit of $6,200. What is his percent of profit? a. 5.48% b. 7.75% c. 12.90% d. 18.20%

b. 7.75% (The investment is the down payment of $80,000. A profit of $62,00 gives Gavin a 7.75% profit: $6,200/$80.000=0.0775 or 7.75%.)

Property that is not like-kind but part of a like-kind exchange is called ___. a. adjusted basis b. boot c. capital asset d. qualified intermediary

b. boot (Sometimes boot is used to help equalize an exchange.)

What do you call proceeds from the sale of an investment greater than the acquisition cost of the investment? a. deferred income b. capital gain c. equity d. leverage

b. capital gain (Capital gains are the proceeds from the sale of an investment greater than the acquisition cost of the investment.)

Which item is deducted from NOI to find cash flow? a. collection losses b. debt service c. vacant losses d. variable expenses

b. debt service (To find the cash flow, you deduct the total annual debt service.)

Value minus debt is best defined as: a. a return b. equity c. yield d. loan to value

b. equity (Equity is the value of the property in excess of the mortgaged indebtedness.)

If a partnership does not pay its debts, the creditors may collect from the personal assets of ___. a. limited partners b. general partners c. stockholders of an incorporated company d. none of the above

b. general partners (A key disadvantage to a general partnership is that general partners have unlimited liability for the acts of the partnership. Each partner can be made to pay the partnership's debts out of his own pocket.)

Investor Betty borrows money from a bank to purchase a small office building. She is able to make the mortgage payments from the rent generated by the leases and still realize a profit. This is an example fo what financing concept? a. appreciation b. leverage c. liquidity d. marketability

b. leverage

In order to qualify for a tax-deferred exchange, the properties must be ___. a. same monetary value b. like for like c. matching equities d. equal mortgage amounts

b. like for like (Property that qualifies for deferred gain treatment under Section 1031 must be like kind, or like-for-like, for example real property for real property.)

A house recently sold for $133,000. It has depreciated by 15% since it was originally purchased. What was the original purchase price? a. $148,000 b. $152,950 c. $156,470.58 d. $218,000

c. $156,470.58 (Step 1: 100%-15%-85%. Step 2: $133,000 (sold price)/0.85 (Book value remaining)=$156,470.58.)

The appraiser estimates that the current construction costs for a subject property are $185,000. The appropriate depreciation rate for the age of the building is 15%. What is the depreciated cost of the building? a. $120,000 b. $123,333 c. $157,250 d. $170,000

c. $157,250 (Step 1: 100%-15%=85%. Step 2: $185,000x85% or 0.85=$157,000.)

Bill sold his real estate for $234,900 and made 28% profit. What did he originally pay for the property (rounded)? a. $65,772 b. $169,128 c. $183,516 d. $206,900

c. $183,516 (He made a 28% profit, which means the house sold for 128% of its original price. To find that original price, divided the sales price by 128% or 1.28: $234,900/1.28=$183,515.62, rounded to $183,516.)

Sam purchased his home six years ago for $194,500, and he has been told that homes have been appreciating at the rate of 3% per year in his neighborhood. What is his home worth today? a. $206,170 b. $212,535 c. $229,510 d. $231,652

c. $229,510 (Step 1: 3%x6 years=18%. Step 2: $194,500x0.18=$35,010. Step 3: $194,500+$35,010=$229,510.)

The maximum amount of gain that would be tax-free to a married couple who sells their personal residence would be ___. a. $125,000 b. $250,000 c. $500,000 d. unlimited

c. $500,000 (The IRS allows a married couple to take a tax-free gain of $500,000 on the sale of their personal residence.)

Investor Tony buys a rental house for $120,000. It rents for $1,200 a month assuming no vacancy. It has annual operating costs of $1,800. What is his capitalization rate on this property? a. 8.3% b. 9.5% c. 10.5% d. 11.2%

c. 10.5% (First, determine the potential gross income: $1,200x12 months-$14,400. Since there are no vacancy losses, this is also its EGI. Find the NOI: $14,400-$1,800=$12,600. Finally, use the IRV formula to find the cap rate: $12,600 (income)/$120,000 (value)=0.105 (rate) or 10.5%.)

You purchased an investment property for $125,000. You later sell it at a loss of $20,000. What is your percent of loss? a. 8.4% b. 8.6% c. 16% d. 19%

c. 16% (Apply for formula: $20,000/$125,000=0.16 or 16% loss.)

A man purchases an investment property for $125,000. He later sells it for $105,000. What is his percent of loss? a. 8.4% b. 11.9% c. 16% d. 19%

c. 16% (He lost $20,000 on the sale. To determine the loss, divide what he lost ($20,000) by what it cost ($125,000): $20,000/$125,000=0.16 or 16% loss.)

When a person declares a tax-free gain on a personal residence, the minimum holding period is ___. a. 12 months b. 18 months c. 2 years d. none required

c. 2 years (The taxpayer must have owned and used the property as a principal residence for at least two of the last five years prior to the date of sale.)

A man purchases land for $50,000. He divides it into three lots that are sold for $20,000 each. What is his percent of profit? a. 6% b. 8.33% c. 20% d. 33.33%

c. 20% (3x$20,000=$60,000). He made $10,000. To determine the profit, divide what he made by what he paid. Profit/Investment)

A man purchases land for $50,000. He divides it into three lots that are sold for $20,000 each. What is his return on investment? a. 8.33% b. 16.67% c. 20% d. 25%

c. 20% (First determine what he made: 3x$20,000=$60,000 (sales price). $60,000-$50,000 (what he paid)=$10,000 (what he made). Next apply the formula: $10,000/$50,000=0.20 or 20% profit)

Bernie just sold his house for $437,000. He bought it 20 years ago for $295,000. What was the total appreciation percentage that he experienced? a. 14.8% b. 32.5% c. 48.0% d. 67.5%

c. 48.0% (Step 1: $437,000-$295,000=$142,000 profit. Step 2: $142,000/$295,000=0.48 or 48%.)

How many times in 10 years could a single person sell their personal home and receive, tax-free, a gain of $250,000? a. 1 time b. 2 times c. 5 times d. not available to single taxpayers

c. 5 times (A single person can take a $250,000 tax-free gain every two years. So, in 10 years, that person could sell his personal home and take advantage of that tax-free gain five times.)

What type of business ownership could be faced with double taxation? a. sole and separate b. S corporation c. C corporation d. limited liability company

c. C corporation (There are two types of corporation, but only the C corp could result in double taxation.)

Of these, which property exchange would MOST LIKELY be eligible for the tax-deferral benefits of a 1031 exchange? a. free-standing store in San Diego for a strip mall in Tijuana b. a personal residence for an office building c. a vacant lot for a gas station d. a yacht for a parking lot

c. a vacant lot for a gas station (Generally, real investment property can be exchanged for any other real investment property regardless of improvements, as long as it's in the United States. Personal property cannot be exchanged for real property.)

What is NOT an advantage of a corporation? a. limited liability b. officers appointed by a board of directors c. double taxation d. living in perpetuity

c. double taxation (A corporation, depending on how it is formed, could result in double-taxation, which is a disadvantage to shareholders.)

Of these assets, which is the LEAST liquid? a. certificates of deposit b. gold c. real estate d. savings bond

c. real estate

Real estate owned by a corporation is owned in___. a. joint tenancy b. partnership c. severalty d. tenancy in common

c. severalty (being separate; a corporation is a legal entity; therefore, real estate ownership by a corporation is an ownership in severalty)

A hundred doctors get together and put in $10 million each to purchase every strip mall in town as they become available over the next several years. This is most likely an example of a ___. a. general partnership b. joint venture c. syndicate d. trust

c. syndicate (Syndicates generally are ongoing projects involving multiple properties that acquire large amounts of capital.)

Sunshine Property is a REIT that owns and operates 79 strip malls. Sunshine Property has 320 shareholders and is managed by a seven-member board of directors. Who, if anyone, are the beneficiaries in this arrangement? a. no one is a beneficiary b. the board of directors c. the investors d. the tenants of the strip malls

c. the investors (In a real estate investment trust, the investors - or shareholders - are the beneficiaries.

The profit realized from selling capital assets is a ___.

capital gain

If a house is currently worth $140,000 and has depreciated 15% since it was purchased, what was the original value? a. $142,590 b. $155,000 c. $161,000 d. $164,705.88

d. $164,705.88 (Step 1: 100%-15%=85%. Step 2: $140,000/85% or (0.85)=$164.705.88.)

An investor buys a vacant lot for $64,500. He splits it into two lots and sells them for $37,200 each. What is his percent of profit? a. 8.6% b. 11.5% c. 13.3% d. 15.3%

d. 15.3% (Remember "what he made divided by what he paid.")

It is May, and Jane is selling her warehouse property to another investor. If she wants to take advantage of the provisions of Section 1031, how long does she have to purchase an acceptable like-kind property as an exchange? a. 30 days b. 45 days c. 120 days d. 180 days

d. 180 days (She must purchase the exchange property within 180 days of closing.)

An individual purchased two lots last year for $10,000 each. The lots just sold for a total of $25,000. What is the percentage of profit? a. 5% b. 12.5% c. 20% d. 25%

d. 25% (Determine what she paid (2x$10,000=$20,000). Lots sold for a total of $25,000, so reduce the total by amount paid to get profit ($25,000-$20,000=$5,000). To get percentage, divide $5,000 profit by total cost of $20,000 ($5,000/$20,000=0.25 or 25%.)

An individual purchased two lots last year for $10,000 each. The lots just sold for a total of $25,000. What is the percent of profit? a. 8% b. 12.5% c. 20% d. 25%

d. 25% (He paid $20,000 for two lots and sold them for $25,000 giving a profit of $5,000. $5,000 (profit)/$20,000 (investment)=0.25 or 25%.)

Janice signs a purchase contract to sell her home for $225,000. She purchased the home several years ago for $162,900. What was the total appreciation percentage that she experienced? a. 6.21% b. 7.24% c. 27.6% d. 38.0%

d. 38.0% (Step 1: $225,000-$162,900=$62,100 profit. Step 2: $62,100/$162,900=0.38 or 38%.)

Which method of organizing a business entity may result in double-taxation? a. subchapter S corporation b. limited liability company c. general partnership d. C corporation

d. C corporation (Of these, only profits from a C corporation could lead to double-taxation. With the other entities, income and losses of the organization are passed through to the individual.)

To qualify for deferring gain on real property exchange, property must be "like-kind." Which of the following trades could NOT qualify? a. an apartment building for a ranch b. vacant land for an 8-plex c. an office building for a shopping center d. GM common stock for AT&T common stock

d. GM common stock for AT&T common stock (Real property held for productive use in a trade or business or held for investment would be eligible for a like-land exchange of real property. Stock would not be eligible.)

All of the following statements are TRUE regarding depreciation EXCEPT ___. a. real estate tax depreciation must relate to an economic life b. when real estate is full depreciated, the major tax benefit is lost. c. all income property can be depreciated for tax purposes d. a building can only be depreciated once

d. a building can only be depreciated once (A building can be depreciated every year for the statutory period allowed by law, depending on whether it's commercial investment property (39 years) or residential investment property (27 1/2 years). The other statements are true.)

What is the advantage of a REIT? a. avoidance of corporate taxes b. continuity of operation c. diversification of investment d. all of the above

d. all of the above (All of these factors are an advantage of participating in a real estate investment trust.)

Which of the following could be borrowed in a tax-deferred exchange? a. income b. like for like c. debt relief d. boot

d. boot (Boot is property that is not likely-kind but that can be a part of a like-kind exchange to make up for a pricing disparity between the like-kind properties. Boot may be borrowed.)

What is NOT part of a tax-deferred exchange? a. boot b. mortgage relief c. like kind d. highest and best use

d. highest and best use (Highest and best use refers to an appraisal practice of evaluating how property may be used to result in its maximum value. The other elements are related to tax-deferred exchange.)

A man may take depreciation for income tax purposes on all of the following EXCEPT ___. a. a home rented to friends b. and apartment building c. a vacant duplex d. land held for future profit

d. land held for future profit (Vacant land, whether held for future profit or not, cannot be depreciated for tax purposes.)

The most important component in determining cash flow is ___. a. appreciation b. depreciable value c. interest d. net operating income

d. net operating income (The NOI is one of the first indicators of the real value or worth of an investment.)

Short-term capital gains are taxed at ___. a. maximum of 15% b. maximum of 20% c. maximum of 28% d. ordinary income tax rates

d. ordinary income tax rates (Short-term capital gains are taxed at the same rate as ordinary income.)

Which item is tax deductible for homeowners? a. credit card interest b. gas service fees c. maintenance fees d. property taxes

d. property taxes (One of the advantages to owning a home is the ability to deduct property taxes paid from one's income tax.)

At least 100 people are required by law to participate in order to form a ____. a. syndicate b. corporation c. limited partnership d. real estate investment trust

d. real estate investment trust (A real estate investment trust (REIT) is a real estate investment business with at least 100 investors that is organized as a trust, with the investors as beneficiaries.)

Which type of business ownership does NOT protect the owner from the business's financial liability? a. corporation b. limited liability company c. limited partnership d. sole proprietorship

d. sole proprietorship (A sole proprietor has sole responsibility for business liabilities.)

Phillip bought an office building several years ago for $195,000. He just sold it for $265,000 and bought an apartment building for $270,000 as part of a 1031 Exchange. When will Phillip have to pay capital gains tax? a. never, by making the exchange, he avoids any capital gains taxes b. now the he sold the office building, but only for the $5,000 difference c. now that he sold the office building, since this was not a like-kind exchange d. when he sells the apartment building, assuming he does not exchange it for another property

d. when he sells the apartment building, assuming he does not exchange it for another property (By making this link-kind exchange, he deferred paying capital gains taxes on the sale of the office building. He can continue to defer if he makes another like-kind exchange when he sells the apartment building; otherwise, he would pay at that point.)

Property exchanges must be of ___.

like-kind

Both boot and mortgage relief are ___.

taxed