Real Estate Unit 18 - Federal Income Taxation of Real Property Ownership

A custom home containing 4,320 square feet was recently constructed on a lot valued at $145,000. Construction costs were $80.25 per square foot, and other fees and costs totaled $12,785. What was the total acquisition cost of the property? A) $504,465 B) $346,680 C) $359,465 D) $145,000

$504,465 4,320 square feet × $80.25 per square foot = $346,680 cost per square foot; $346,680 + $145,000 cost of lot + $12,785 other fees and costs = $504,465 total cost of property.

Investors may be able to defer taxable events on investment property by following the IRS prescribed rules for A) 1031 tax-deferred exchanges. B) selling the property as a short-term gain. C) recapturing depreciation. D) holding onto the property until long-term capital gains rules apply.

1031 tax-deferred exchanges.

An investor puts $11,000 down when purchasing a property for $90,000. The house is now worth $100,000, and his loan balance is $75,000. What is the percentage of increase in equity? A) 12% B) 12.7% C) 127% D) 1.27%

127% Amount received = base × rate100,000 - 75,000 = 25,000 present equity - 11,000 original equity =14,00014,000 = 11,000 × rate14,000 ÷11,000 = 1.27 or 127%

A homeowner listed her real estate for sale at $100,000. If her cost was 80% of the listing price, what will her percentage of profit be if her real estate is sold for the listing price? A) 10% B) 15% C) 25% D) 20%

25%

In 1992, a family purchased their house for $126,500. They made no major improvements during the time they owned the property. Recently, they sold the property for $162,275. What was their percentage of gross profit? A) 49.7% B) 128.3% C) 28.3% D) 77.95%

28.3% $162,275 (sales price) - $126,500 (cost) = $53,775 (profit) $35,775 / $126,500 = 0.283

A buyer purchased a home for $150,000 and financed $100,000. The equity has increased by $20,000. What is the percentage of gain in equity? A) 20% B) 25% C) 40% D) 30%

40% Amount received = base × rate150,000 − 100,000 = 50,000 original equity20,000 = 50,000 × rate20,000 ÷ 50,000 = 0.40 or 40%

Basis

AKA cost basis

Capital Improvement

Any improvement that extends the life or increases the value of a piece of property.

Which of the following statements is/are TRUE? Some of the expenses of a vacation home, that is also a rental property, may be tax deductible if the taxpayer/owner limits their private use of the home. An installment sales contract may provide tax benefits to the seller by spreading the sales income over several tax years. A) Neither I nor II B) I only C) Both I and II D) II only

Both I and II

Mortgage interest, property taxes, and repairs are tax-deductible items for homeowners. True False

False

There are no limits on the amount of mortgage interest and property tax deductions for homeowners. True False

False

Capital Loss

If the amount realized is less than the adjusted basis

Which of the following is not a tax deductible loan expense? A) Mortgage prepayment penalties B) Mortgage interest payments on a principal residence C) Interest paid on overdue taxes D) Loan discount points

Interest paid on overdue taxes

Which of these regarding tax-deferred exchanges is FALSE? A) The tax is deferred, not eliminated, so whenever the investor actually sells the newly acquired property without the use of an exchange, the capital gain will be taxable. B) Owners of a principal residence can use that residence in a tax-deferred exchange. C) There must be a property transferred and a property received; these properties cannot be sold. D) Real estate investors can defer taxation of capital gains by exchanging property versus selling it and receiving taxable profit.

Owners of a principal residence can use that residence in a tax-deferred exchange.

Tax-Deferred Exchange

Real estate investors can defer taxation of capital gains by exchanging property versus selling it and receiving taxable profit. A tax-deferred exchange offers significant tax advantages because no matter how much a property has appreciated since its initial purchase, it may be exchanged for another property and the taxpayer may be able to defer taxes on the entire gain.

Federal income tax laws do NOT currently allow a homeowner to deduct which of the following expenses from taxable income? A) Mortgage interest B) Repairs or maintenance C) Discount points D) Real estate taxes

Repairs or maintenance

Which expense is NOT tax deductible for homeowners? A) Depreciation taken for a home office B) Property taxes paid for the home C) Mortgage interest paid on a home loan D) Repairs to the home

Repairs to the home

An investor is selling a commercial property that is free and clear for a price of $875,000. The investor is planning on doing a 1031 tax-deferred exchange and acquiring another investment property. The investor decides to reinvest $800,000, but to keep $75,000 of the proceeds for other purposes. Which of these is TRUE? A) The investor may not keep any of the proceeds and must reinvest the entire amount that he realizes from the sale. B) The investor may keep all or any portion of the funds. The portion the investor keeps and does not reinvest will be called "boot" and is taxable. C) The investor must still invest the $75,000 into real estate. D) If the investor keeps any funds from the sale, the entire amount of $875,000 may become taxable as a capital gain.

The investor may keep all or any portion of the funds. The portion the investor keeps and does not reinvest will be called "boot" and is taxable.

Adjusted Basis

The owner of a property can add to the cost basis, the cost of any physical capital improvements that add value to the property or prolong its life.

Which of the following is NOT true about tax treatment of the sale of a principal residence? A) The tax-free exclusion can only be used once in a taxpayer's lifetime. B) A married couple filing jointly may exclude from taxation up to $500,000 of capital gain. C) A single person may exclude from taxation up to $250,000 of capital gain. D) To qualify for the exclusion from capital gains taxation, the property must have been the principal residence for two of the last five years.

The tax-free exclusion can only be used once in a taxpayer's lifetime.

A house sold for $120,000 at a 15% profit. The original value was $ $104,350 (rounded). True False

True

Installment sales are a method of deferring the payment of capital gains taxes and is often used by owners of investment property. True False

True

Residential homeowners who have sold their primary residence at a loss cannot write off the loss on their income tax the year following the sale. True False

True

The IRS rules permit residential property owners to depreciate a part of their homes that may be used for home offices. True False

True

To calculate the gain on a home, a property owner should determine its purchase price, the monies expended for improvements to the home, its sales price and any expenses associated with the sale. True False

True

Installment Sale

When a seller finances the sale of the seller's property (as with the use of a contract for deed or purchase money mortgage), or when the seller is to receive all or some portion of the sales price in a year or years other than the year of sale

Which of these is FALSE regarding deducting losses from real estate? A) Investors may be able to deduct losses from their real estate investments. B) The amount of loss that may be deducted depends on whether you are an active participant in the management, the amount of loss, and the source of income against which the loss is to be deducted. C) The tax code cites specific rules for active and passive income and losses and is subject to change. D) You can deduct losses on your principal residence.

You can deduct losses on your principal residence.

Long-Term Capital Gain

a gain on assets that were held for 12 months or longer

Short-Term Capital Gain

a gain on assets that were held less than 12 months

Gain

a general increase in the value of an assets or property

Boot

a property is exchanged for another property that is worth substantially more or less money. When this happens, cash or personal property may be included in the transaction to even out the value of the exchange.

Fran sold her house, which she owned in severalty, and had a capital gain of $175,000. In order to exclude that gain from her income for tax purposes, she must A) have lived in the house for three years. B) have lived in the house for two of the last three years. C) have lived in the house for two of the last five years. D) be at least 55 years of age.

have lived in the house for two of the last five years.

Homeowners will be able to avoid capital gains tax on the sale of their residence if they A) have owned and occupied the home for two years or more. B) are married. C) are 55 years old or older. D) have owned the home for two years or more.

have owned and occupied the home for two years or more.

When preparing an annual income tax return, a homeowner may be able to deduct all of the following EXCEPT A) mortgage interest on a first home. B) mortgage interest on a third home. C) mortgage interest on a second home. D) real estate taxes.

mortgage interest on a third home.

Depreciation

or cost recovery, allows an investor to recover the cost of an income-producing asset by taking tax deductions over the period of the asset's useful life

Cost Basis

owner's initial cost for the real estate (purchase price plus allowable closing expenses)

Amount Realized

sales price minus allowable closing expenses

The profit homeowners receive from the sale of their principal residence may be A) subject to long-term federal income tax if the profit exceeds the excluded limits. B) rolled over into the purchase of a more expensive property without any tax liability once every 24 months. C) taxed at a lower rate because depreciation is deductible from each annual income tax return. D) excluded from taxation every year up to a statutory limit of $500,000 per married couple filing jointly.

subject to long-term federal income tax if the profit exceeds the excluded limits.

Like-Kind Properties

the like-kind requirement is met when real estate is exchanged for real estate. An apartment building can be exchanged for an office building or gas station, and the exchange will still qualify as like-kind.

Capital Gain

the profits realized from the sale or exchange of property

An investor who does not want to pay capital gains tax when selling an investment property should consider A) not filing an itemized return. B) moving into the property for a year to get a primary residence exclusion. C) using a 1031 tax-deferred exchange. D) claiming the investment property as his primary residence.

using a 1031 tax-deferred exchange.