Chapter 18

Question 1

Which entity provides limited liability protection, separating personal assets from business debts for real estate investors?

Answer 1

Limited Liability Company (LLC)

Question 2

tax
liability

Answer 2

the amount of
tax owed to the government
based on taxable income,
deductions, and credits.

Question 3

syndicate

Answer 3

group of
individuals or entities that
come together to pool
resources and invest in real
estate or other ventures.

Question 4

REMIC (Real
Estate
Mortgage
Investment
Conduit)

Answer 4

complex type of
investment vehicle that holds
a pool of mortgage loans and
issues multiple classes of
securities backed by the cash
flows from the underlying
mortgages.

Question 5

REIT (Real
Estate
Investment
Trust)

Answer 5

company that
owns, operates, or finances
income-generating real
estate and allows investors
to invest in real estate
without directly owning
properties

Question 6

passive
activity

Answer 6

an
investment in which the
investor does not materially
participate in the
management or operation of
the business

Question 7

opportunity
cost

Answer 7

the
potential benefit that is
forgone when one alternative
is chosen over another.

Question 8

non-income
property

Answer 8

real
estate that does not generate
rental income

Question 9

liquidity

Answer 9

the ease
with which an asset can be
converted into cash without
affecting its market price

Question 10

leverage

Answer 10

the use of
borrowed capital to increase
the potential return on
investment.

Question 11

income
property

Answer 11

real
estate that generates rental
income from tenants

Question 12

general and
limited
partnerships

Answer 12

A general partnership consists
of partners who share
management responsibilities
and liability for the
partnership’s debts. A limited
partnership has both general
partners who manage the
business and limited partners
who have limited liability and
no management authority.

Question 13

gain
on sale

Answer 13

the profit
realized from the sale of an
asset, such as real estate,
after subtracting the adjusted
basis and selling expenses.

Question 14

cost
recovery

Answer 14

also known as
depreciation, is the process
of deducting the cost of a
tangible asset over its useful
life for tax purposes.

Question 15

cash
flow

Answer 15

the net income
generated by an investment
property after subtracting
operating expenses,
mortgage payments, and
vacancy losses

Question 16

capital
gain

Answer 16

the profit
realized from the sale of an
asset, such as real estate or
stocks, that exceeds its
purchase price.

Question 17

appreciation

Answer 17

the increase
in the value of an asset over
time

Question 18

adjusted
basis

Answer 18

the original
cost of an asset, such as real
estate, adjusted for
depreciation, capital
improvements, and other
factors.

Question 19

An individual buys a small office building as an investment and participates actively in the management and operation of the building. This is an example of

Answer 19

direct investment

Question 20

A real estate investment can take a long period of time to sell. For the investor, this means that real estate is

Answer 20

relatively illiquid

Question 21

A homeowner sold her house and had net proceeds of $191,000. Her adjusted basis in the home was $176,000. She immediately bought another house for $200,000. What was her capital gain?

Answer 21

$15,000

Question 22

One way investors measure the yield of an investment is by

Answer 22

dividing cash flow by the investor’s equity

Question 23

A homeowner paid $285,000 for a house three years ago. The house sells today for $339,000. How much has the property appreciated?

Answer 23

19%

(1) subtracting the estimated current market value from the price originally paid (339,000 - 285,000 = 54,000) and (2) dividing the result by the original price (54,000 / 285,000 = . 19 or 19%)

Question 24

Bill Holdfast owns a small retail property that he inherited from his father. There are no mortgages or interest expenses connected with the property. Bill takes an annual cost recovery expense of $5,000. The property has a monthly gross income of $1,500 and monthly operating expenses of $500. Bill’s taxable income from this property will be taxed at a rate of 24%. What is the tax liability for the year?

Answer 24

1,680

Annual gross operating income ($1,500 x 12 = $18,000) - annual operating expenses ($500 x 12 = $6,000) = annual net operating income ( $12,000); annual net operating income ($12,000) - cost recovery expense ($5,000) = taxable income ($7,000); taxable income ($7,000) x tax rate (24%) = tax liability ($1,680)

Question 25

Cost recovery is allowed as a federal tax deduction on

Answer 25

income properties

Question 26

A homeowner bought a house five years ago for $250,000. Since then, the homeowner has spent $6,000 to pave the driveway and has added a central heating/air-conditioning system at a cost of $10,000. What is the homeowner’s adjusted basis if the house is sold today?

Answer 26

$266,000

Question 27

All investors desire their investments to increase in value. However,

Answer 27

the more the investor stands to gain, the greater the risk that the investor may lose

Question 28

Cash flow is a measure of how much pre-tax or after-tax cash an investment property generates. To derive cash flow it is therefore necessary to exclude

Answer 28

cost recovery expense

Question 29

A house sold for $350,000. The seller paid a brokerage commission of six percent, legal fees of $600, and had other closing costs of $3,000. What are the net proceeds from the sale?

Answer 29

$325,400

Question 30

Which of the following best describes a Real Estate Investment Trust?

Answer 30

Investors own shares in a trust that receives 75% of its income from real estate investments

Question 31

As a general rule, in deriving taxable income on an investment property, it is legal to

Answer 31

deduct interest payments from income

Question 32

Which of the following are limitations on the exclusion of capital gain on the sale of a house?

Answer 32

The seller must have owned it for two years of the previous five, used it as a principal residence for two years during that period, and not claimed an exclusion in the previous two years

Question 33

Taxable income produced by an income property is

Answer 33

gross income minus expenses minus building depreciation