Unit 6: Real Estate Investments
Investors can use the first $25,000 of losses from rental property to offset income from any source provided the investor actively participates in the management of the property and has taxable income before the deduction of no more than
$100,000
investors can use the first $25,000 of losses from rental property to offset income from any source provided the investor actively participates in the management of the property and has taxable income before the deduction of no more than
$100,000. The deduction is reduced by $0.50 for every dollar of income over $100,000 and is thus eliminated completely when income reaches $150,000.
an installment sale. Payments from the sale of a property must be received over two or more years to qualify for an installment sale. Income tax is paid each year based on the amount received during that year.
$198,000. The adjusted basis is equal to the original cost plus improvements minus depreciation. In this case, $200,0000 + $18,000 ‒ $20,000 = $198,000.
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?
$5,000. Cash flow is the total amount of money remaining after all expenditures have been paid, including taxes, operating costs, and mortgage payments. The cash flow produced by any given parcel of real estate is determined by at least three factors: amount of rent received, operating expenses, and method of debt repayment. Property appreciation does not factor into the calculation of cash flow.
If investor A exchanges a building worth $200,000 for investor B's building worth $150,000, a car worth $20,000, and $30,000 in cash, investor A has a taxable boot of
$50,000.
Delayed Exchange
- the property must be identified within 45 days and the exchange completed within 180 days of transfer of the exchanged property - Identification of the exchange property must meet 1 of 3 guidlines: 1. ID of up to 3 properties of any value w/ the intent to purchase one of them 2. ID of more than 3 properties as long as the combined market value doesn't exceed 200% of the market value of the property relinquished 3. ID of more than 3 properties with a combined market value exceeding 200% of the market value of the relinquished property but you must acquire 95% of the market value of all of the properties ID'd
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, an expense deduction for tax purposes taken over the period of ownership of income property. See also cost recovery.
Clarice purchased raw land for $1,000 per acre. She pays $80 per acre for annual real estate taxes and has various expenses of about 8% per year. By how much per year must the land appreciate in order for Clarice to break even?
6%. 8% × 1,000 = $80 + $80 = $160 divided by $1,000 = 16%.
Janus would like to invest in real property. She is a broker and knows quite a bit about the ins and outs of commercial properties, including investments and management. She would like to go in on the purchase of a commercial office building with several of her business associates to house her real estate firm and perhaps other real estate‒related businesses, such as a mortgage lender and a title company. While she doesn't have the financial resources to purchase the property by herself, she would prefer to run the entire operation by herself. Which of the following business organizations would fit her objectives?
A limited partnership real estate investment syndicate
By directing funds to real estate investment trusts (REITS), real estate investors can take advantage of the same tax benefits as mutual fund investors. Which of the following does represent a REIT?
A mortgage REIT buys and sells mortgages with its income made from mortgage interest and origination fees. An equity REIT pools an assortment of large-scale income properties and sells shares to investors. The main profits from an equity REIT are from profits derived from the properties it owns.
real estate mortgage investment conduit (REMIC)
A tax device that allows *cash flows from an underlying block of commercial mortgages* to be passed through to security holders without being subject to income taxes at the level of trustee or agent.
Which of the following is calculated by adding the initial cost of an investment property, plus the cost of subsequent improvements, minus the amount of any depreciation claimed as a tax deduction?
Adjusted basis
What are the three factors that determine cash flow?
Amount of rent received operating expenses method of debt repayment
Arnold has watched television commercials promoting the use of pyramiding as a real estate investment technique. If Arnold wants to try this approach, which action would he take?
Contact his bank to arrange a refinance of one of his investment properties, thereby obtaining cash to buy another rental house
diversification
Distribution of investments among several companies or several types of investments (such as savings accounts, individual retirement accounts, stocks, bonds, mutual funds, and real estate) in order to average the risk of loss.
What is the difference between an equity REIT and a real estate syndicate?
Equity REITs pool properties and sell shares to investors, while real estate syndicates pool several investors' funds to purchase one property.
Jim owns several real estate assets that he has purchased through the years in a variety of ways. He has been very successful in relying on his real estate agent, Clair, to inform him when certain types of properties go on the market. If you were Clair, what types of sales would you be watching for Jim?
Foreclosures REOs Short sales
Joan has two rental properties that are exactly the same size. One is a new duplex near downtown Austin, and the other is a duplex built in 1971 in Manor. What happens to the duplex in Manor if she can't rent it out?
If rent cannot cover expenses, there will be a negative cash flow.
Which of the following real-property objectives is also a real-property security objective?
Income stream Real estate securities generate an income stream without the headaches of property management.
Which statement is TRUE about a syndicate?
It is a private or public business venture to own property.
Why is it risky for an investor to purchase raw land with the expectation that there will be growth in the area in the future?
Its intrinsic value is difficult to determine. Its potential appreciation is difficult to determine.
What is the degree of risk associated with real estate investment?
Moderately high
boot
Money or property given to make up any difference in value or equity between two properties in an exchange.
What is it called when an investor refinances existing holdings and uses the proceeds to buy more properties?
Pyramiding
George is a real estate investor; he has 100% ownership of several houses in the DFW area. What type of investments are the houses considered?
Real-property assets Real estate investments generally fall into one of two types: real-property assets (such as single-family homes, apartments, shopping centers, and office buildings) real estate securities (such as first-lien mortgage notes, Fannie Mae stocks, Freddie Mac bonds, or Ginnie Mae certificates). A REIT is a real estate investment trust, a security that is invested in real estate directly, either through properties or mortgages.
capital gain
Sales price minus selling expenses and adjusted basis
Syndications often come under securities registration laws administered by the federal
Securities and Exchange Commission (SEC). The sale of a limited partnership interest in a syndication is subject to state and federal laws concerning the sale of securities. outline fraudulent practices, require the registration of securities before sale, and require full disclosure by providing a prospectus to all potential investors. Real estate salespeople selling shares in syndications may be required to obtain securities licenses and special state registration.
Taking advantage of which strategy reduces taxes to an investor in low-income housing?
Tax credits
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.
Which of the following is considered a benefit of real estate investment?
The availability of tax shelters
What is the definition of capital gain?
The difference between the adjusted basis of property and its net selling price
real estate investment trust (REIT)
Trust ownership of real estate by a group of at least 100 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
When used for real estate investments, the form of ownership used by a syndication is usually
a partnership.
Jacob has invested in a real estate investment syndicate that purchased a shopping center. Which does NOT describe the advantages of his participating in the syndicate?
acob will be able to sell his interest in the syndicate upon the approval of the syndicate's management. Syndicate interests are generally more difficult to sell on the open market than real estate, which makes this a disadvantage rather than an advantage of participating in a syndicate. Approval by the syndicate's management may be required before an investor can sell his interest in the project. Some partnership agreements may require that such interest be sold only to another member of the syndicate. TRUE: Jacob enjoys the same federal income tax advantages as a sole-owner real estate investor. Jacob was able to invest only a modest amount of money but owns part of a large-scale, high-profit, high-risk shopping center. Jacob owns a certain percentage of a particular parcel of real estate.
pyramiding
acquiring additional properties through refinancing properties already owned and then reinvesting the loan proceeds in additional property.
If an investor purchases a property for $200,000, makes $100,000 in improvements, and takes $50,000 in depreciation, the investor's
adjusted basis is now $250,000.
tax credit
amount by which tax owed is reduced directly A tax credit is greater value than a tax deduction.
depreciation deduction
an annual tax allowance for the depreciation of property may be taken only on personal property and improvements to land and only if they are used in a trade or business or for the production of income. Depreciation cannot be claimed on land (because it does not wear out) or on a personal residence (with the exception of that portion of a residence that is used for a business).
An investor may defer federal income taxes on a portion of the gain on the sale of a property, provided all sales proceeds are not received during the year of the sale. This describes
an installment sale.
An investor may defer federal income taxes on a portion of the gain on the sale of a property, provided all sales proceeds are not received during the year of the sale. This describes
an installment sale. Payments from the sale of a property must be received over two or more years to qualify for an installment sale. Income tax is paid each year based on the amount received during that year.
Real Estate Investment Trust (REIT)
an organization that purchases, owns, and manages real estate for its investors
A parcel of property that increases in value because of its location in the center of an affluent and rapidly growing neighborhood is an example of
appreciation through intrinsic value.
adjusted basis
basis plus the cost of physical improvements and minus depreciation claimed as a tax deduction
State laws passed requiring registration of securities to protect the public from investing schemes are commonly called
blue-sky laws
leverage
borrowed money to finance the bulk of an investment and to magnify the rate of return.
If an investor's adjusted basis in a property is $400,000 and the property has a net selling price of $500,000, the investor has a $100,000
capital gain.
An investor decides to liquidate property previously acquired through a 1031 exchange. If she is not acquiring replacement property in this transaction, which statement regarding capital gains taxes would be TRUE?
capital gains taxes are due on the total capital gain accumulated since the purchase of the initial property. Capital gains taxes are deferred, not eliminated, in a 1031 exchange. An investor can keep exchanging upward in value, adding to assets for as long as she lives without ever personally having to pay any tax on the profits. Upon the liquidation of exchanged property (without another replacement), capital gains taxes are due on all gains accumulated since the purchase of the initial property.
Operating expenses include all of the following EXCEPT
debt services. The cash flow produced by any given parcel of real estate is determined by at least three factors: (1) amount of rent received, (2) operating expenses, (3) method of debt repayment. Operating expenses include general maintenance of the building, repairs, utilities, taxes, and tenant services (such as security systems).
risks generally are
directly proportional to leverage. A high degree of leverage presents the investor and lender with a high degree of risk; lower leverage results in a lower risk. An investor should be prudent in the use of leverage; when property values drop in an area or vacancy rates rise, the highly leveraged investor may be unable to pay even the financing costs of the property.
Which of the following is similar to a mutual fund?
equity REIT. Much like mutual fund operations, equity REITs pool an assortment of large-scale income properties and sell shares to investors.
Sara is a real estate investor; she owns several homes in Galveston that she rents out on both short- and long-term leases. She has mortgages on the homes that she pays monthly. What is the portion of her mortgages that is applied to the principal for each loan considered?
equity buildup. The portion of an investor's mortgage payments applied to the principal represents equity buildup and increases the value of the investor's ownership interest in the asset with each remittance.
basis
financial intrest the IRS gives to owner in investment property dollar amount associated with an asset to determine annual depreciation and gain or loss on the sale of the asset. The owner's basis is the cost of the property; adding the value of any capital expenditures for improvements to the property and subtracting any depreciation claimed as a tax deduction yields the adjusted basis.
An investment syndicate is to be set up to allow all members to share equally in the managerial decisions, profits, and losses involved in the venture. Which of the following is the business structure BEST suited to these investors?
general partnership. organized so that all members of the group share equally in the managerial decisions, profits, and losses involved with the investments. In a limited partnership, limited partners lose only as much as they invested, nothing more.
George owns several types of real estate investments. He owns two houses that he rents out, and he has sold one other that he carried back a mortgage on. What is the benefit of holding the mortgage as a security over the rental properties as assets?
has an income stream from the security without having to manage the properties. While both types of investments produce income, he needs to manage the properties he owns. He has no equity buildup and does not benefit from appreciation in holding the mortgage but he gets the benefit of both in the rental properties that he owns. There are risks to holding both types of investments.
Real estate investments
include both real-property assets (such as single-family homes, apartments, shopping centers, and office buildings) and real estate securities (such as first-lien mortgage notes, Fannie Mae stocks, Freddie Mac bonds, or Ginnie Mae certificates).
inflation
increase in the volume of money and credit relative to available goods resulting in a substantial and continuing rise in the general price level.
appreciation
increase in the worth or value of a property due to economic or related causes, may prove to be either temporary or permanent
To be exempt from federal income tax, real estate investment trusts (REITS) must be structured to
invest at least 75% of its assets in real estate, other REITs, securities, or cash.
One of the disadvantages of investing in real estate is
investors need expert help.
tax shelter
legal means by which an investor may reduce or defer payment of part of her federal income tax.
Stan wants to invest in real property. Rather than be a sole owner, Stan would prefer to pool his resources with other people to own and develop a small office building. He would prefer not to take part in the day-to-day responsibilities of the organization. What type of business venture would best fit his goals?
limited partnership real estate investment syndicate. A real estate investment syndicate is a business venture in which a group of people pools its resources to own or develop a particular piece of property, or both. Under a limited partnership syndicate agreement, the general partner organizes, operates, and is responsible for the entire syndicate. The limited partners are passive investors with no voice in the organization and direction of the operation.
What is the BEST way for an investor to get the maximum return on an initial investment?
making a small down payment, paying low interest rates, and spreading mortgage payments over a long period. An investor often stands to make more money by investing borrowed money. Low mortgage payments spread over a long period result in a higher cash flow because they allow the investor to retain more income each month; conversely, higher mortgage payments contribute to a lower cash flow but pay off the loan faster.
A property's equity represents its current value less
mortgage indebtedness. An owner's equity is the current market value of the property less the mortgage indebtedness.
If a property has a yearly income of $100,000 and ownership expenses of $110,000, the property provides the investor $10,000 in
negative cash flow. Cash flow refers to the dollars remaining after all expenses of ownership have been paid. Cash flow may be positive (if the dollars remaining after all expenses of ownership have been paid are greater than $0) or negative (if the dollars remaining after all expenses of ownership have been paid are less than $0). In this case, it is negative ($100,000 income - $110,000 expenses = -$10,000 negative cash flow).
cash flow
net spendable income from an investment, determined by deducting all operating and fixed expenses from the gross income. If expenses exceed income, a negative cash flow is the result. dollars remaining after all expenses of ownership have been paid. Cash flow is positive if the dollars remaining after all expenses of ownership have been paid are greater than $0; otherwise, cash flow is negative.
1031 Exchange
permits investors to defer taxes - 45 days to identify a new property - 180 days to close on a new property
Income from interest, stock dividends, and royalties is
portfolio income. A passive real estate investor (one who contributes money but has no voice in management operations) generally can offset investment losses only against investment income. He cannot use a loss from a passive activity to shelter active income (such as wages), or portfolio income (such as stock dividends, bank interest, and capital gains). Using losses from rental property to offset income from any source is reserved for active real estate investors. If a person (1) materially participates in the activities, (2) spends at least 750 hours in real-property businesses, and (3) performs more than 50% of his personal services for the year in real-property businesses, then the person would be considered a real estate professional and would not be subject to the passive loss limitations. The requirements must be met on a yearly basis.
Real-property objectives
positive cash flow equity buildup tax savings property appreciation.
Clara owns Ginnie Mae certificates as part of her real estate investments. What type of investments are the certificates considered?
real-property securities. Real estate investments generally fall into one of two types: real-property assets (such as single-family homes, apartments, shopping centers, and office buildings) real estate securities (such as first-lien mortgage notes, Fannie Mae stocks, Freddie Mac bonds, or Ginnie Mae certificates). A REIT is a real estate investment trust, a security that is invested in real estate directly, either through properties or mortgages.
Shareholders in a real estate investment trust (REIT) generally
receive most of the trust's income each year.
installment sale
transaction in which the sales price is paid in two or more installments over two or more years. If the sale meets certain requirements, a taxpayer can postpone reporting such income to future years by paying tax each year only on the proceeds received that year.
exchange
transaction where all or part of the consideration is the transfer of like-kind property (such as investment real estate for investment real estate).
intrinsic value
value independent of any benefit to humans result of a person's individual choices and preferences.
An investor sold a six-unit apartment building and purchased a 10-unit building with same market value. The investor gained $40,000 on the sale of the six-unit building, but did not utilize a 1031 exchange. Therefore, this gain
will be taxed. If an investor sold an apartment building but did not participate in a 1031 exchange, the gain on the sale of the apartment building will be taxed at the time of the sale.
