MRE_Unit22

depreciation

(1) In appraisal, a loss of value in property due to any cause, including physical deterioration, >functional obsolescence, and external obsolescence. (2) In real estate investment, a deduction for tax purposes taken over the period of ownership of income property, based on the property's acquisition cost.

syndicate

A combination of people or firms formed to accomplish a business venture of mutual interest by pooling resources. Typical syndicate projects include highrise apartment buildings and shopping centers. Syndicate members realize some profit from rents collected on the investment, but the main return usually comes when the syndicate sells the property.

A woman refinanced her house and used the proceeds to purchase two rental properties. This method of increasing her holdings is called A) pyramiding. B) depreciating. C) exchanging. D) syndicating.

A) The answer is pyramiding. Pyramiding through refinancing uses the value of the original property to drive the acquisition of additional properties while retaining all properties acquired.

As part of a Section 1031 exchange, an investor had to give the other party $111,500 and a 1957 Chevrolet. The cash and car are A) equity. B) boot. C) like kind. D) collateral.

B) The answer is boot. The cash and car are boot as they make up the difference in value or equity between the exchanged properties.

Which factor affects a property's potential price increase the MOST? A) Deflation B) Inflation C) Location D) Purchase price

B) The answer is inflation. Inflation results from an increase in the amount of money in circulation; the value of money declines, which means that interest rates and prices rise.

straight-line depreciation

Depreciation taken periodically in equal amounts over an asset's useful life.

investment syndicate

In a real estate, the parties own and/or develop property, with the main profit generally arising from the sale of the property. This structure permits people with only modest capital to invest in large-scale operations.

liquidity

The ability to sell an asset and convert it into cash, at a price close to its true value, in a short period of time.

inflation

The gradual reduction of the purchasing power of the dollar, usually related directly to increases in the money supply by the federal government.

pyramiding

The process of acquiring additional property by refinancing property already owned and investing the loan proceeds in additional properties.

pyramiding through sale

an investor first acquires a property and then improves it for resale at a substantially higher price. The profit from the sale of the first property is used to purchase additional properties. The disadvantage of this method is that the proceeds from each sale are subject to taxation.

qualified intermediary (also known as an accommodator or a facilitator)

considered a safe harbor by the IRS and is essential for a delayed exchange of payment of tax per a boot

due diligence

exploration of the benefits and drawbacks of the investment

Private syndication

generally involves a small group of closely associated or experienced investors.

Public syndication

involves a much larger group of investors who may or may not be knowledgeable about real estate as an investment.

real estate mortgage investment conduit (REMIC)

A tax entity that issues multiple classes of investor interests (securities) backed by a pool of mortgages.

exchanges

A transaction in which all or part of the consideration is the transfer of like-kind property (e.g., real estate for real estate).

An investor made an initial real estate investment of $45,000 and subsequently made $20,000 worth of improvements to the property. If the investor subtracts depreciation from the initial cost and adds the cost of improvements, what will be the result? A) Adjusted basis B) Salvage value C) Capital gain D) Basis

A) The answer is adjusted basis. Adjusted basis is the original cost plus capital (long-term) improvements minus cost recovery (depreciation). Depreciation lowers an investor's adjusted basis. The lower an investor's adjusted basis, the larger will be the capital gain to be taxed when a property is sold. The depreciation tax deductions taken along the way are somewhat taken back by capital gains taxes upon sale.

For purposes of a tax-deferred exchange, one parcel of investment real estate is considered of like kind to A) another parcel of investment real estate, even if they have different uses. B) any asset as long as it has the same market value as the real estate. C) another parcel of investment real estate of the same use. D) any asset that would otherwise qualify for a like-kind exchange

A) The answer is another parcel of investment real estate, even if they have different uses. The key is that both parcels must be held for investment and not be owner-occupied, and they cannot be located in a foreign country.

The primary source of tax shelters in real estate investments comes from which accounting concept? A) Depreciation B) Boot C) Recapture D) Net operating income

A) The answer is depreciation. The greatest source of real estate investment tax shelter is depreciation. Depreciation is a tax concept according to which an investor writes off—as if it were an annual outlay—part of the original cost of a property during each year of its ownership. The IRS decides the time period on which this computation must be based. A shorter period would give larger deductions. Currently, the IRS allows depreciation over 27.5 years for residential real estate and 39 years for commercial real estate. Depreciation is often called cost recovery. Interestingly, while a property is depreciating in book value, it may also be appreciating rapidly at the same time in market value.

Investing in real estate has the disadvantage of A) lack of liquidity. B) lower loan-to-value ratios. C) slower appreciation. D) few tax benefits.

A) The answer is lack of liquidity. Real estate cannot be easily sold.

Accumulated equity is A) not realized as cash unless the property is sold, refinanced, or exchanged. B) realized as cash at the close of each tax year. C) not realized as cash unless the property is sold. D) realized as cash once equity is established.

A) The answer is not realized as cash unless the property is sold, refinanced, or exchanged. Accumulated equity is not realized as cash unless the property is sold, refinanced, or exchanged.

A woman refinanced her house to pay off her old loan and generate $100,000 cash, which she used to purchase two rental properties. This method of increasing her holdings is called A) pyramiding. B) depreciating. C) syndicating. D) exchanging.

A) The answer is pyramiding. Pyramiding through refinancing uses the value of the original property to drive the acquisition of additional properties while retaining all properties acquired.

The type of real estate investment that is required by federal law to distribute 90% of its income to its shareholders is the A) real estate investment trust. B) time-share estate. C) limited partnership. D) general partnership.

A) The answer is real estate investment trust. One of the federal requirements of a real estate investment trust is that it distribute at least 90% of its income to its shareholders.

cost recovery

An Internal Revenue Service term for depreciation.

intrinsic value

An appraisal term referring to the value of a property unaffected by a person's personal preferences.

appreciation

An increase in the worth or value of a property due to economic or related causes, which may prove to be either temporary or permanent; opposite of depreciation.

blue-sky laws

Any pooling of individuals' funds raises questions of securities registration under federal and state securities laws

The two main factors affecting appreciation are A) local demographics and market value. B) inflation and intrinsic value. C) local demographics and intrinsic value. D) inflation and market value.

B) The answer is inflation and intrinsic value. The two main factors that affect appreciation are inflation and intrinsic value.

Someone looking for a tax-advantaged investment similar to a mutual fund would probably invest in a A) limited partnership. B) real estate investment trust. C) general partnership. D) corporation.

B) The answer is real estate investment trust. A real estate investment trust is similar to a mutual fund. Both are marketed by stock brokers rather than by real estate agents and allow the investor to own a portion of a big real estate property.

A man made an initial real estate investment of $245,000. He subsequently made $80,000 worth of improvements to the property. If the man subtracts depreciation from the initial cost and adds the cost of improvements, what will be the result? A) Basis B) Salvage value C) Adjusted basis D) Capital gain

C) The answer is adjusted basis. Adjusted basis is the original cost plus capital (long-term) improvements minus cost recovery (depreciation). Depreciation lowers an investor's adjusted basis. The lower an investor's adjusted basis, the larger will be the capital gain to be taxed when a property is sold. The depreciation tax deductions taken along the way are somewhat taken back by capital gains taxes upon sale.

The main factors that affect a property's potential price increase are A) deflation and a stable market. B) deflation and purchase price. C) inflation and intrinsic value. D) location, location, location.

C) The answer is inflation and intrinsic value. Inflation results from an increase in the amount of money in circulation; the value of money declines, which means that interest rates and prices rise. The intrinsic value of real estate is a result of the individual choices and preferences of buyers for a given geographic area.

The effect of leveraging is the result of A) market forces on an anticipated future sales price measured against the full original price paid. B) investor manipulation as measured only against the actual cash invested. C) market forces on the original purchase price as measured against the actual cash invested. D) investor manipulation and an anticipated future sales price measured against the actual cash invested.

C) The answer is market forces on the original purchase price as measured against the actual cash invested. The effect of leveraging is to provide a return that reflects the result of market forces on the original purchase price as measured against the actual cash invested.

Tax credits

Certain tax credits are allowed for the renovation of older buildings, low-income housing projects, and historic property. A tax credit is a direct reduction in the tax due rather than a deduction from income before tax is computed. Tax credits encourage the revitalization of older properties and the creation of low-income housing.

A seller is selling an investment property. The original cost of the property was $80,000. The selling price is $225,000. The seller paid an 8% commission and $2,000 in closing costs. Two years ago, the seller made $10,000 worth of improvements to the property. Depreciation is $15,000. What is the seller's adjusted basis in the property? A) $80,000 B) $90,000 C) $65,000 D) $75,000

D) The answer is $75,000. The seller's adjusted basis is the original cost of the property plus the cost of capital improvements the seller has made, less the depreciation (cost recovery) enjoyed while owning the property. To calculate the adjusted basis, cost is added to improvements and the total is reduced by depreciation: $80,000 cost + $10,000 improvements cost - $15,000 depreciation = $75,000 adjusted basis.

To qualify as a real estate investment trust, what percentage of the trust's income must come from real estate? A) 25% B) 35% C) 50% D) 75%

D) The answer is 75%. To qualify as a REIT, at least 75% of the trust's income must come from real estate. Investors purchase certificates in the trust, which invests in real estate or mortgages or both, with profits distributed to investors.

Real estate is an avenue of investment open to those interested in holding property primarily for increasing value, which is called A) valuation. B) growth. C) appreciative. D) appreciation.

D) The answer is appreciation. Real estate is an avenue of investment open to those interested in holding property primarily for increasing value, which is called appreciation.

Which statement is TRUE about a syndicate? A) Members must hold title as joint tenants. B) Blue-sky laws do not apply. C) Most profit on the investment is realized from rents. D) It is a private or public business venture to own property.

D) The answer is it is a private or public business venture to own property. A real estate investment syndicate is a private or public business venture in which people pool their resources to own or develop a particular piece of property. Syndicate members may hold property as tenants in common or joint tenants. The main return on the investment usually comes with the sale of the property. Syndicates could be impacted by blue-sky laws, which are federal and state securities laws.

A property's cost basis is A) what it would cost to purchase the property today. B) increased by the amount of depreciation taken for tax purposes. C) the net amount that the seller received on the investor's purchase price. D) the investor's initial cost of the property.

D) The answer is the investor's initial cost of the property. The amount of any depreciation claimed as a tax deduction is subtracted from the basis to find the property's adjusted basis.

A buyer uses a 1031 tax-deferred exchange to buy a property. The buyer is MOST likely A) an investor who will need to live in the house two out of five years to avoid capital gains taxes. B) exchanging a primary residential home for another primary home. C) an investor who is selling and buying a primary residence. D) using the exchange to defer payment of capital gains taxes on an investment property.

D) The answer is using the exchange to defer payment of capital gains taxes on an investment property. Investors may use 1031 tax-deferred exchanges to avoid paying capital gains at closing on investment properties. The investor will still owe the taxes in the future. Owners of a primary home may avoid paying any capital gains taxes if they live in the property two out of five years.

Passive investors

Investors who do not actively participate in the management or operation of the real estate are considered passive investors. Passive investors may not use losses to offset active income derived from active participation in real estate management, wages, or income from stocks, bonds, and the like.

accelerated cost recovery system (ACRS)

Method for claiming tax deductions for certain property purchased before 1987 in which it was possible to claim greater deductions in the early years of ownership, gradually reducing the amount deducted in each year of useful life.

boot

Money or property given to make up any difference in value or equity between two properties in an exchange. The value of the boot is added to the basis of the property for which it is given.

capital gain

Profit earned from the sale of an asset. = property's adjusted basis - its net selling price (exceeding adjusted basis)

income property

Property held for current income as well as a potential profit upon its sale.

adjusted basis

See basis: cost of the property plus the value of any capital expenditures for improvements to the property, minus any depreciation allowable or actually taken. This new basis is called the adjusted basis. investor's initial cost of the real estate + cost of any physical improvements subsequently made to the property - amount of any depreciation claimed as a tax deduction = property's adjusted basis

equity buildup

That portion of the loan payment directed toward the principal rather than the interest, plus any gain in property value due to appreciation.

basis

The financial interest that the Internal Revenue Service attributes to an owner of an investment property for the purpose of determining annual depreciation and gain or loss on the sale of the asset. If a property was acquired by purchase, the owner's basis is the cost of the property plus the value of any capital expenditures for improvements to the property, minus any depreciation allowable or actually taken. This new basis is called the adjusted basis. = investor's initial cost of the real estate

cash flow

The net spendable income from an investment, determined by deducting all operating and fixed expenses from the gross income. When expenses exceed income, a negative cash flow results.

leverage

The use of borrowed money to finance an investment.

real estate investment trust (REIT)

Trust ownership of real estate by a group of individuals who purchase certificates of ownership in the trust, which in turn invests the money in real property and distributes the profits back to the investors free of corporate income tax. To quality, at least 75% of the trust's income must come from real estate. Investors purchase certificates in the trust, which in turn invests in real estate or mortgages (or both). Profits are distributed to investors.