Unit 23: Real Estate Investment

A seller is selling an investment property. The original cost of the property was $80,000. The selling price is $125,000. The seller paid an 8 percent commission and $1,000 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 total capital gain? A) $45,000 B) $39,000 C) $90,000 D) $80,000

The answer is $39,000. Capital gain is computed by subtracting the seller's adjusted basis, costs of sale, and brokerage commission from the selling price. In the seller's case, the selling price ($125,000) is reduced by the seller's adjusted basis ($75,000), by the brokerage fee (8% of $125,000 = $10,000), and by closing expenses ($1,000): $125,000 selling price - $75,000 adjusted basis - $10,000 brokerage fee - $1,000 closing expenses = $39,000 capital gain.

A seller is selling an investment property. The original cost of the property was $80,000. The selling price is $125,000. The seller paid an 8 percent commission and $1,000 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 total capital gain? A) $45,000 B) $80,000 C) $90,000 D) $39,000

The answer is $39,000. Capital gain is computed by subtracting the seller's adjusted basis, costs of sale, and brokerage commission from the selling price. In the seller's case, the selling price ($125,000) is reduced by the seller's adjusted basis ($75,000), by the brokerage fee (8% of $125,000 = $10,000), and by closing expenses ($1,000): $125,000 selling price - $75,000 adjusted basis - $10,000 brokerage fee - $1,000 closing expenses = $39,000 capital gain.

A small multifamily property generates $50,000 in rental income, $10,000 in expenses, and $35,000 in debt service. The property appreciates about $25,000 each year. What is the cash flow on this property? A) $15,000 B) $5,000 C) $25,000 D) $30,000

The answer is $5,000. The property brings in $50,000 and has costs of $45,000 in property expenses and mortgage payments. That leaves only $5,000 in positive cash flow. Appreciation on a property that is not yet sold does not create cash flow and is not considered in this computation: $50,000 - $10,000 - $35,000 = $5,000.

If an investor spends $100,000 for rental property, makes a $20,000 down payment, and then sells the property five years later for $125,000, the return over five years is A) 25 percent of the original investment. B) 80 percent of the original investment. C) 125 percent of the original investment. D) 16 percent of the original investment.

The answer is 125 PERCENT OF THE ORIGINAL INVESTMENT. If an investor spends $100,000 for rental property, makes a $20,000 down payment, and then sells the property five years later for $125,000, the return over five years is 125 percent of the original investment ($25,000. Disregarding ownership expenses, the return is not 25 percent). ($25,000 compared with $100,000), but 125 percent of the original amount invested ($25,000 compared with $20,000).

A business venture in which people pool their resources to own or develop a particular piece of property is called A) leverage. B) a syndicate. C) pyramiding. D) a real estate investment trust (REIT).

The answer is A SYNDICATE. A business venture in which people pool their resources to own or develop a particular piece of property is called a syndicate

When considering an investment in real estate, the prospective investor should consider all of the following EXCEPT the A) possible effects of inflation on the property. B) anticipated appreciation of the property. C) intrinsic value of the property. D) assessed valuation of the property.

The answer is ASSESSED VALUATION OF THE PROPERTY. The anticipated appreciation of the property, possible effects of inflation on the property, and the intrinsic value of the property are all things an investor should consider. The assessed valuation is usually "old" information and may have little relevance to the investor.

Any pooling of individuals' funds raises questions of securities registration under federal and state securities laws, known as A) pie-in-the sky laws. B) anti-pyramiding laws. C) blue-sky laws. D) clear-sky laws.

The answer is BLUE-SKY LAWS. Any pooling of individuals' funds raises questions of securities registration under federal and state securities laws, known as blue-sky laws

As part of a Section 1031 exchange, an investor had to give the other party $11,500 and a 1953 Chevrolet. The cash and car are A) equity. B) like kind. C) boot. D) collateral.

The answer is BOOT. The cash and car are boot

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

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. In 1986, the IRS lengthened the time over which depreciation would be spread to 31.5 years. 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.

A real estate investment A) usually guarantees a profit, with little risk involved. B) does not guarantee a profit but involves little risk. C) does not guarantee a profit and involves a high degree of risk. D) usually guarantees a profit but involves a high degree of risk.

The answer is DOES NOT GUARANTEE A PROFIT AND INVOLVES A HIGH DEGREE OF RISK. A real estate investment does not guarantee a profit and involves a high degree of risk.

One method a real estate investor may use to defer capital gains tax is to A) obtain the maximum amount of leverage. B) exchange one property for a like-kind property. C) build a reserve account for items that are likely to wear out. D) sell the property for cash only.

The answer is EXCHANGE ONE PROPERTY FOR A LIKE-KIND PROPERTY. The tax on capital gains is normally due when a taxpayer files a tax return for the previous year. Complying with Section 1031 of the U.S. Internal Revenue Code will defer the tax due until a future date. This is commonly called a tax-free or like-kind exchange.

Advantages of an investment in real estate include all of the following EXCEPT A) the use of leverage to increase rates of return. B) tax deductions. C) the possibility of a tax-deferred exchange. D) high liquidity.

The answer is HIGH LIQUIDITY. The possibility of a tax-deferred exchange, the use of leverage to increase rates of return, and tax deductions are all advantages of an investment in real estate. High liquidity (the ability to convert an asset to cash) is not an advantage that real estate enjoys.

The investor who sells property on an installment sale basis A) is taxed on all of the gain in the year the property is sold. B) gives the buyer the privilege of deferring all the federal income tax liability. C) is taxed on that part of the gain received in each year's installment payments. D) gives the buyer all the federal income tax liability.

The answer is IS TAXED ON THAT PART OF THE GAIN RECEIVED IN EACH YEAR'S INSTALLMENT PAYMENTS. The idea of an installment sale is to spread the tax liability out over the years of the installment sale; the taxpayer pays taxes only on the portion received in each taxable year.

How quickly an asset may be converted into cash is called A) transferability. B) liquidity. C) convertibility. D) rate of return.

The answer is LIQUIDITY. How quickly an asset may be converted into cash is called liquidity

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

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 small group of closely associated or experienced investors is typically a A) private enterprise. B) public syndication. C) private syndication. D) public enterprise.

The answer is PRIVATE SYNDICATION. A small group of closely associated or experienced investors is typically a private syndication

A larger group of investors who may or may not be knowledgeable about real estate as an investment are typically those MOST likely to invest in a A) public enterprise. B) public syndication. C) private syndication. D) private enterprise.

The answer is PUBLIC SYNDICATION. A larger group of investors who may or may not be knowledgeable about real estate as an investment are typically those most likely to invest in a public syndication

Purchasing a property using leverage, refinancing it after it has appreciated, and using the cash from the refinancing to purchase additional property is one form of A) pyramiding. B) consolidation. C) contribution. D) plottage.

The answer is PYRAMIDING. Pyramiding is the term used to describe the purchasing of property and then refinancing the investment after it has appreciated and using the borrowed funds to purchase new properties.nternal Revenue Code will defer the tax due until a future date. This is commonly called a tax-free or like-kind exchange.

Some investments have failed to produce returns greater than the A) average certificate of deposit. B) federal discount rate. C) rate of inflation. D) federal funds rate

The answer is RATE OF INFLATION. Some investments have failed to produce returns greater than the rate of inflation

Disadvantages of investment in real estate include all the following EXCEPT A) relatively low degree of risk. B) lack of liquidity. C) active management or cost of hiring professional property manager. D) high cost to acquire.

The answer is RELATIVELY LOW DEGREE OF RISK. Disadvantages of investment in real estate include the high cost of acquisition, the necessity of active management or cost of hiring a professional property manager, lack of liquidity, and the high degree of risk.

Cash flow is a term that refers to the A) amount of money flowing into and out of a property. B) bookkeeping function that accounts for the cash each day. C) taxes, operating expenses, and loan payments on the property. D) total amount of income left after all expenses have been paid.

The answer is TOTAL AMOUNT OF INCOME LEFT AFTER ALL EXPENSES HAVE BEEN PAID. Cash flow is the total amount of income remaining after all expenses have been paid. If the cash flow from rents is not enough to cover all expenses, negative cash flow will result.

Which situation would result in the highest degree of leverage? A) Using borrowed funds entirely B) Using your own funds entirely C) Using more of your own funds than those that you borrow D) Using more of the funds that you borrow than your own funds

The answer is USING BORROWED FUNDS ENTIRELY. Leverage means using other people's money to own property. The more funds you are able to borrow to own property, the higher degree of leverage. If an investor could borrow 100 percent of the purchase price, this would be the highest degree of leverage.

Which situation would result in the highest degree of leverage? A) Using your own funds entirely B) Using more of the funds you borrow than your own funds C) Using borrowed funds entirely D) Using more of your own funds than those you borrow

The answer is USING BORROWED FUNDS ENTIRELY. Leveraging means using other people's money to own property. The more funds one is able to borrow to own property, the higher degree of leverage. If an investor could borrow 100 percent of the purchase price, this would be the highest degree of leverage.