Unit 22 Investing in Real Estate

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) 125% of the original investment. B) 25% of the original investment. C) 16% of the original investment. D) 80% of the original investment.

The answer is 125% 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 $25,000 ($125,000 - $100,000), which is 125% of the original investment of $20,000, disregarding ownership expenses. $25,000 ÷ $20,000 = 1.25 or 125%.

For residential property, the statutory depreciation period for federal tax purposes is A) 31 years for commercial real estate. B) 27.5 years for residential real estate. C) 35 years for commercial real estate. D) 29 years for residential real estate.

The answer is 27.5 years for residential real estate. The statutory depreciation period for federal tax purposes is 39 years for commercial 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) Basis B) Adjusted basis C) Capital gain D) Salvage value

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.

A real estate mortgage investment conduit (REMIC) has complex rules regarding A) transfer. B) all of these. C) liquidation. D) qualification.

The answer is all of these. These very technically defined entities have existed since the Tax Reform Act of 1986.

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

The cost of an income-producing asset can be recovered through the process called A) cost basis. B) capital gain C) accumulation. D) depreciation.

The answer is depreciation. Depreciation, or cost recovery, allows an investor to recover the cost of an income-producing asset through tax deductions taken over the asset's useful life.

The MOST prevalent form of real estate investment is A) direct ownership. B) a real estate syndicate. C) a real estate investment trust (REIT). D) a limited partnership.

The answer is direct ownership. The most prevalent form of real estate investment is direct ownership.

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.

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

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

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.

A person's individual decisions and preferences to live in a certain geographic area is A) intrinsic value. B) preferential value. C) market value. D) personal value.

The answer is intrinsic value. The result of a person's individual choices and preferences for a given geographic area is intrinsic value.

The result of a person's individual choices and preferences for a given geographic area is A) preferential value. B) personal value. C) market value. D) intrinsic value.

The answer is intrinsic value. The result of a person's individual choices and preferences for a given geographic area is intrinsic value.

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

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.

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

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.

When a taxpayer sells real property and receives payment on an installment basis, the taxpayer pays tax on interest received as A) capital gain. B) depreciated cost basis. C) boot. D) ordinary income.

The answer is ordinary income. Interest received by the taxpayer when real property is sold on an installment basis is taxable as ordinary income.

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) syndicating. B) depreciating. C) exchanging. D) pyramiding.

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.

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.

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.

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

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.

All of the following are associated with a Section 1031 exchange EXCEPT A) boot. B) the elimination of capital gains tax. C) qualified intermediary. D) like kind.

The answer is the elimination of capital gains tax. In a 1031 exchange, the capital gains tax is deferred, not eliminated. Whenever the investor sells the property, the capital gain will be taxed.

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

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.

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

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 and any other income a property may generate are not enough to cover all expenses, negative cash flow will result.

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

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% of the purchase price, this would be the highest degree of leverage.

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

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% of the purchase price, this would be the highest degree of leverage.