Taxation and Investment

A property is appraised at $150,000 and assessed for tax purposes at 50% of value. What are the annual taxes if the tax rate is $80 per $1,000?

$6,000 (First, determine the taxable assessed value: $150,000 x 0.50 = $75,000. Then divide by 1,000 and multiply by $80 to get $6,000, which is the annual tax: $75,000 / 1,000 = 75 $1,000- taxing units; 75 x 80 = $6,000 (or, $75,000 x 0.080 = $6,000).)

Mark is purchasing a new home for $300,000. He is making a 20% down payment. What is Mark's equity in his new home?

$60,000 (On a new home purchase, the owner's equity is limited to the amount of the down payment. In this case, Mark made a 20% down payment: $300,000 x 0.20 = $60,000. He has $60,000 in equity in the home.)

Helen bought a small office building for 50,000. She sold it 10 years later for 48,000, what is her percent of loss

4%

Investor Amy made a 34,000 down payment on a duplex she purchased for 115,200, paying 2,000 in closing costs. She determines a pre tax cash flow of 2,460. What is Amy's cash on cash return for this property

6.8%

Tony is interested in another commercial property that shows a gross operating income of 64,000 and expenses of 12,000. If he wants to get at least 8% return on his investment, what would he be willing to pay for the property?

650,000

Investor Amy bought a duplex for 115,200. Each unit rents for 800 a month. She assumes 5% vacancy/ collection loss annually and has no additional income sources on the property. The annual operating expenses for the property are 9,600. What is the NOI ...

8,640

Tony purchased a bigger warehouse for his expanding wholesale food distribution company at a cost of 500,000. The land on which it sits is valued at 150,000. What is the amount that Tony will be able to deduct next year as depreciation ...

8,974

Ad Valorem

A Latin phrase meaning "according to value": used to refer to taxes assessed not he value of property.

Home Acquisition Debt

A loan that a taxpayer takes out to buy, build, or substantially improve a qualified home.

Home Equity Debt

A loan that does not qualify as home acquisition debt but is secured by a qualified home.

capitalization rate

A percentage rate of return used by investors to calculate the present value of future income. Used for an income approach to appraisal. Also called Rate.

pro forma statement

A schedule of the projected income and expenses for a real estate investment over a given period.

Special Assessment

A tax levied only against properties that benefit from a public improvement (eg. a swear or street light) to cover the cost of the improvement; creates a special assessment lien (an involuntary lien).

ADA (Americans with Disabilities Act)

A wide-ranging federal civil rights law, signed in 1990, that prohibits, under certain circumstances, discrimination based on disability.

management agreement

A written agreement that governs the relationship between the property owner/investor and the property manager and outlines the duties of the property manager.

improvements

Additions to real property - can be natural (e.g., trees or a lot feature), but usually they are man-made, substantial fixtures, such as buildings.

Mill

An amount equal to one-tenth of one cent, used in expressing tax rates.

Equity

An owner's unencumbered interest in property; the difference between the value of the property and the liens against it.

A single-family residence that is converted into a doctor's office is categorized as mixed-use space.

False (A single-family residence that is converted into a doctor's office is considered to be office space.)

Property taxes are based on how much money a person earns.

False (Property taxes are ad valorem taxes, which means they are based on how much a property is worth.)

Real property taxes are administered by the state.

False (Property taxes are administered locally. States so not generally benefit directly from property tax.)

Residents of the Happy Acres subdivision in Anytown request a special assessment to pay for a new street lights. If approved, this special assessment tax would be paid by all property owners in Anytown.

False (Special assessment taxes are imposed only on the owners of the properties within the special assessment district who will benefit from the improvement.)

The role of an assessor is to determine the amount of property tax due.

False (The assessor does not determine the tax that is due. An assessor assigns an assessed value to each property in order to proportion the tax burden fairly.)

If William and Liz sold the property for $165,000, they would NOT have to pay capital gains tax on their net proceeds because it's below the $500,000 limit for married couples (assuming that they has not claimed that exemption in the past two years).

False (While up to $500,000 of gain is tax free for married couples every two years, remember that this applies only to a primary residence. They were selling rental property, so that exemption does not apply.)

Investors Mr. and Mrs. Smith sell a rental property, making $185,000 profit. They would NOT have to pay capital gains tax on their net proceeds because it's below the $500,000 limit for married couples.

False (While up to $500,000 of gain is tax free for married couples every two years, this applies only to a principal residence. They were selling rental property, so that exemption doe snot apply. Next, we''ll look at property taxes.)

effective gross income

Potential gross income, less a figure for vacancy and collection losses.

Capital Gain

Profit made from an investment.

tax shelter

Property or other investments that give owners certain income tax advantages, such as deductions for property taxes, mortgage interest, and depreciation.

1031 Exchange

The Internal Revenue Code Section that allows a taxpayer to sell an investment property and purchase another investment property in it space without paying capital gains on the proceeds from the sale. Also called Like-Kind Exchange or Tax-Deferred Exchange.

The advantage of a home equity loan over credit is that interest is tax deductible.

True (One reason people often consolidate other debts into a home equity loan is to write off the interest paid.)

The principal that an investor pays on a mortgage is an example of using leverage to build equity.

True (Paying principal does indeed help build equity, and when the principal is coming from income generated by an investment, the investor is taking advantage of leverage.)

Property tax liens are paid first when a lender foreclosure on a borrower's property.

True (Property tax liens always have a higher priority over other previously recorded liens. Next, we'll quickly look at equity.)

Mark lives in a village where the assessment rate is 40%. His house was determined to have a market value of $200,000, so the assessed value of his property is $80,000.

True (The assessment is 40% of the market value of $200,000, or $80,000.)

William and Liz's original equity in that property was equal to their down payment of $30,000.

True (Their down payment is the only equity they have in the property at first.)

Depreciation

a loss of value in a piece of property for any reason

property manager

a person hired by a real property owner to administer, market, merchandise, and maintain property, especially rental property

John has his investment dollars tied up in a number of different outlets. He's bored of his portfolio and wants to find something new that interests him. What would be least likely to be an exchange that would allow him to defer capital gains taxes

a stallion for a mare

net operating income

income before interest and taxes (gross potential income-Vacancy loss+miscellaneous income=effective gross income-expenses=NOI)

a property that houses a research and development facility is typically categorized as

industrial property

Which of the following items are tax-deductible?

interest on a home equity loan, mortgage interest on a vacation home, and property taxes on a principal residence. (Maintenance and depreciation are not tax deductible on a principal residence. however, maintenance can be tax deductible on rental property.)

Property taxes create a

involuntary specific lien (Property tax creates an involuntary specific lien, which means the lien is on the specific property only, not any other assets of the property owner.)

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 of what financing concept?

leverage

cash flow

measure of cash inflow and outflow from an investment, positive cash flow means more money is coming into the business than is leaving it, negative cash flow is the exact opposite

LLC investments owns a building with two specialty stores on the first floor, class B office space on the second floor, and a loft apartment on the top floor this is an example of ...

mixed-use property

Land can be depreciated

never

risk

probability unexpected events will occur

profit and loss formulas

profit= what you made/ what you paid loss= what you lost/ what it cost

what is the role of a qualified intermediary

safeguard the assets of each property in the transaction

Of these, which is MOST LIKELY to be paid for with a special assessment?

sewer repair (Special assessments are primarily used to pay for infrastructure costs for a specific targeted project, often for a single street or neighborhood.)

Which of these investment types do you think is the most liquid?

shares of stock (Stocks are traded publicly every day relatively easily, although losing some principal is not unheard of in the stock market. While antique furniture can be sold, the market for a particular piece can affect someone's ability to sell it quickly. IRAs often restrict access to funds except under specific circumstances. Commercial real estate may be the most illiquid of these.)

which properties qualify as commercial property

single- family residence

liquidity

the ability to convert an asset into cash quickly without the loss in principal

debt service

the amount of money paid at regular intervals toward reducing the principal and interest owed on a debt

return on investment

the gain/ profit an investor experiences from an investment relative to its cost

return of investment

the protection of an investor's equity in an investment

Phillip bought an office building several years ago fro $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 Philip have to pay capital gains taxes?

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

Brian owns an office building he wants to sell. Recently he found a strip mall across town that he would like to buy. Can he avoid paying capital gains tax on the sale of the office building if he buys the strip mall ...

yes

Kent is single and sold his principal residence for $325,000. He bought the house 30 years ago for $150,000. He has selling expenses of $15,000. Kent meets all the conditions for the section 121 exclusion. What is Kent's recognized gain or loss?

$0 (Since the amount of the Section 121 exclusion ($250,000) is greater than the realized gain of $160,000, there is no recognized gain.)

A property is appraised at $250,000 and assessed for tax purposes at 40% of value. What are the quarterly taxes if the tax rate is $60 per $1,000?

$1,500 (First, determine the assessed value: $250,000 x 0.40 = $100,000. Then divide by 1,000 to find the taxing units: $100,000 / 1,000 = 100. Multiply that by the tax rate of $60 per $1,000 to find the annual tax: 60 x 100 = $6,000. To find the quarterly tax, divide by 4: $6,000 / 4 = $1,500.)

Now, how much can Richard deduct from his annual taxes when his depreciated basis on the apartment building is $300,000?

$10,909 (The value of improvements is divided by the number of years the deduction is allowed, which is 27.5 for residential investment property. So, $300,000 / 27.5 = $10,909.)

Property owner Jack lives in Top Town. His house is assessed at $40,000. The property tax for XYZ Schools is $60 per $1,000. What will Jack pay in property tax for the school levy?

$2,400 (Divide the assessed value by 1,000: $40,000 / 1,000 = 40. Then multiply by the tax rate of $60 per $1,000 to find the property tax owed to the school district: 40 x 60 = $2,400.)

A property is appraised at $175,000 and assessed for tac purposes at 50% of value. What are the semi-annual taxes if the tax ratio is $65 per $1,000?

$2,843.75 (First, determine that the assessed value: $175,000 x 0.50 = $87,500. Then divide by 1,000 to find the number of taxing units: $87,500 / 1,000 = 87.5. Multiply the taxing units by the rate to find the annual taxes: 87.5 x 65 = $5,687.50. Finally, divide the annual taxes by 2, since the question is asking for semi-annual taxes: $5,687.50/2=$2,843.75.)

A property with a market value of $100,000 is assessed at 50%. The annual taxes are $1,250. What is the tax rate?

$25 per $1,000 (First, determine the assessed value is $50,000 ( $100,000 x 0.50). Divide that by 1,000 to get 50 taxing units. Finally, divide the annual taxes $1,250 by 50 to get a tax rate of $25 per $1,000.)

Richard is the owner of a four-unit apartment building. The property is valued at $375,000. If the land is valued at $75,000, what is the basis for the depreciation calculation?

$300,000 (Land is never depreciation so the value of the land is subtracted from the amount to find the basis for the depreciation calculation, in other words, the value of improvement. In this case: $375,000 - $75,000 = $300,000.)

Property in Joe's town is assessed at 50%. The property tax rate is $18 per $1,000. If Joe's annual taxes are $720, what is the market value of his property?

$80,000 (First, you can find the assessed value by dividing the taxes by the tax rate: $720 / 0.018 = $40,000. Then divide the assessed value by the tax ratio: $40,000 / 0.50 = $80,000.)

which actions do you think a property owner could take to increase the NOI

- cutting expenses - increasing the occupancy - raising the rent

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

20%

Doris owns a four-unit apartment building. The rent on each unit is $500 a month. She averages 10% vacancy and collects $500 a year from the coin-operated washer and dryer in the building's basement. What is the potential gross income for Doris's building?

24,000

Residential rental property can be depreciated over______ years

27 1/2

If William and Liz has NOT financed the purchase of the property, but paid $150,000 cash for it and sold it five years later for $165,000, what was their return on investment?

10% (They would have made a $15,000 profit on a $150,000 investment, so 15,000/150,000 = .1 or only 10%. Over five years, the average annual rate of return would be only 2%. You can surely see the benefit of leveraging other people's money to make a profit.)

Investor Tony buys a rental house for 120,000, it rents for 1,200 a month and assuming no vacancy it has annual operating costs of 1,800. What is the capitalization rate on this property?

10.5%

the operating statement on Ken's rental property shows an effective gross income of 48,750 and an NOI of 28,000. He pays 2,900 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

12,400

a man purchases an investment property for 125,000 and later sells it for 105,000 what is his percent of loss

16%

vacancy and collection losses

Estimate of how much future income may be lost when a building isn't full or tenants don't pay the rent.

before tax cash flow

Gross amount of income available before taking taxes into consideration.

Last year, a new plant was built in a rural area, bringing many workers. The area has few retail storefronts to provide services, and lease rates were very high. In time, developers began constructing much needed retail space. As the supply of retail space in the area rises, what would you expect to happen to lease rates in the area in the short term?

Lease rates should fall slightly from their high points (The law of supply and demand tells us that lease rates should fall slightly from their high points as the supply of retail space in the area rises.)

the most important component in determining cash flow is

NOI

Francois wants to sell a warehouse he owns in Seattle and buy a strip mall in Vancouver, BC. Is this transaction eligible as a like-kind exchange?

No (Any investment property can be exchanges for any other investment property, except when property in the United States is exchanged for foreign property.)

Lindsay sold her house a year ago and bought a new one when she transferred to a new job. She did not pay capital gains taxes on her old home. Lindsay just learned she is very ill and will soon not be able to care for herself. She wants to sell her house and move back home to be closer to her family. Will she have to pay capital gains taxes when she sells her house?

No (Because she cannot care for herself, she can invoke an exemption for the rule of residing two out of the last five years at the property as principal residence.)

Frank is tired of living in the city and wants to move. Frank decides to sell his Manhattan condo and buy a little cottage in the mountains, Would this transaction be eligible as a like-kind exchange?

No (To be eligible under Section 1031, only business or investment properties can be involved.)

straight line depreciation

Simple depreciation method that takes the total cost of a building and divides that by the number of years the building is expected to be useful.

leverage

The effect borrowed funds have on investment returns.

tax depreciation

The expensing of the cost of business or investment property over a set number of years, determined by the IRS to be an asset's useful life (27 1/2 years for residential property; 39 years for non-residential property).

Appreciation

The increase in value of an asset over time.

cash on cash return

The ratio of income generated by the property to the cash investment (down payment and settlement costs) in the property. (cash flow/acquisition cost=cash on cash return)

Market Value

The theoretical price that a piece of property would bring if placed on the open market for a reasonable period of time, with a buyer willing (but not forced) to buy, and a seller willing (but not forced) to sell, if both buyer and seller were fully informed as to possible use of the land.

potential gross income

The total of the rent that could be collected before losses are subtracted and miscellaneous income is added. (NOI/Value((sales price))=capitalization rate)

Assessed Value

The value placed on a property by a taxing authority for the purpose of taxation. With real estate this value is usually a fraction of true value.

operating statement

Used by the current owner and illustrates total revenues generated for a given period based on rent rolls and management style.

Lucy has been applying every annual bonus she gets from work to the principal on her mortgage. Consequently, she pays off her 20-year mortgage in 17 years. Her lender charges her a prepayment penalty fee. Can she deduct that fee from her income tax?

Yes (If a lender charges a penalty for paying off a mortgage early, that penalty amount is deductible.)

Do you think that a homeowner could lose equity in his or her home?

Yes (If the value of the property decreases more quickly than a borrower can repay a loan, that property owner can lose equity in the property, This was a scenario in the collapse of the housing market when many homeowners were "underwater" with their mortgages, meaning, they owed more than the property was worth.)

You don't pay a special assessment tax that was imposed to put in sidewalks in your neighborhood because you don't want the liability of keeping the sidewalks free of snow and ice. Since you did not vote for the improvement, do you think the city can put a lien on your property to cover that assessment?

Yes (Real estate tax liens on special assessment taxes are involuntary liens against a specific property. They don't need to ask your permission.)

Liz is getting ready to sell her house and has no idea what it might sell for. Before listing, Liz checks the county clerk's office and sees that a house next door, which just sold got $220,000, is assessed at $110,000. Her house is assessed at $140,000. Do you think Liz can get a rough estimate of how much she might be able to ask for her house form this information?

Yes (She should be able to see that the market value fo the home is about double its assessed value, which means that the level of assessment is 50% of full market value, This could give her a rough estimate of her home's market value.)

In January, Mary moved for a new job. She used the Section 121 provisions to avoid taxable gain on her home. Mary commutes 35 miles every day for work. The following March, she gets a new job in another town 110 miles from her home. Can Mary invoke the Section 121 provisions even though her last move was less than two years ago?

Yes (Since the difference in commuting miles is greater than 50, Mary is eligible to invoke the provisions of Section 121 again to move even though it has been less than two years since her last move.)

equity

an owner's unencumbered interest in property, the difference between the value of the property and the liens against it

Public Accommodation

facility that is owned, leased, leased to, or operated by a private entity

property that is not like-kind but part of a like-king exchange is called ...

boot

NOI - debt service =.....

cash flow

Which of the following circumstances are exceptions to the two-year provision of Section 121 of the Taxpayer Relief Act of 1997?

change in place of employment, disaster, divorce, and health considerations. (Marriage is the only item listed that is not exempted. Divorce and disaster qualify as unforeseen circumstances.)

boot

extra, non like kind of property that can be a part of a like kind exchange to make up for pricing disparity between like kind properties