chapter 3: accounting and tax Flashcards
what are the two types of accounting in Real estate?
cash accounting
Generally Accepted Accounting Principles (GAAP)
Generally Accepted Accounting Principles (GAAP)
based upon accrual accounting
financial transactions are recorded in the period in which they have economic effect regardless exchanged cash
Cash accounting
transactions only recorded when the effect the cash account directly
which accounting type is used the most in real estate? Why?
Generally Accepted Accounting Principles (GAAP)
it is a more accurate depiction of economic activity that took place at a certain period than cash accounting
what are three main classes of revenues that real estate allow you to have?
rent
expense reimbursement (tenant’s payment towards operating costs)
income from exploitation of the asset for uses other than leasing of space
how must one record rent if the rent changes over time?
using the straight line method
this averages the lease payments of the life of the lease
what is percentage rent?
only used by some landlords
they receive extra rent calculated as a percent of their tenant’s sales revenue
natural breakpoint (from percentage rent)
rent / participation percentage
what are expense reimbursements?
sometimes, tenants are expected to cover part of all the operating expenses associated with the property they occupy
include amounts need to cover operation of tenant’s own space
include Common Area Maintenance (CAM)
Common Area Maintenance (CAM)
contribution to the cost of the common area of the building
ancillary income
the revenue generated that’s not from a company’s core products and services
where can ancillary income come from?
can come from multiple sources
depends on the type of transactions that the landlord has constructed
early termination fees
paid by tenants when they leave prematurely by their own choice
exist to compensate landlords for the absence of expected cash flow
what do the termination fees depend on?
depend on the remaining lease term
Net Operating Income
property income
selling, general, and administrative expense
Costs of managing assets and enterprise
what are all the amortization and capitalized costs?
leasing commissions
tenant allowances
depreciation
interest
earnings before taxes
income taxes
leasing commissions
fees paid to real estate brokers for identifying and negotiating the business terms of the leases
tenant allowances
the costs of preparing space for new occupants
tax pass through entities: what do they do and give examples?
help you pay less taxes without avoiding
partnerships
limited liability corporations
REITs
REMICS
net income
the profit after all expenses and taxes have been subtracted form operating revenue
dividends
some of the net income (profits) distributed to asset owners
what is the most significant asset held by a real estate company?
property portfolio
long term real estate assets
investments in real estate
landlord being a lender to lower-credit tenants
above/below market leases
explain a landlord being a lender to lower-credit tenants
he gives loans to his tenants that they will then repay through rent
what are short term assets in real estate?
cash
A/R
prepaid expenses
what are long term liabilities in real estate?
bank line of credit (LOC)
notes and bonds
mortgages
bank line of credit (LOC)
a revolving credit agreement with a bank that functions as a corporate credit card
borrower can draw money against the line then repay it at will
bank demands fee for borrowing and if you fail to pay it all, there will be interest
mortgages
long-term borrowings secured by an interest in real property
what is the most common form of mortgage loan?
fixed-rate self-amortizing loan
fixed-rate self-amortizing loan
loan that require you to pay interest every month as well as part of the principal
if you pay it all on time, by then end of the principal payment due, there should be no more principal due
what are short term liabilities in real estate?
A/P
tenant deposits
tenant deposits
amounts placed in escrow with the landlord that are pledged against tenant’s performance of its obligations under a lease agreement
If tenant performs, deposits will be released at end of lease term
net worth accounts
net worth accounts record the owner’s equity in the entity
includes owner’s investments and retained earnings
also known as shareholder’s equity or partner’s capital (in partnership)
owner’s investment account
stores equity contributed to the enterprise by owners
working capital
current assets - current liabilities
historical costs
costs at which you acquired the assets
market value
the current value of the asset regardless of historical cost
what does component depreciation do?
allocates part of the real estate purchase to land
divides the acquisition costs of asset across the physical components of a structure
gives more accurate depreciable lives to each of these components
asset impairment
asset is worth less than what it is stated in the book balance
historical cost - accumulated depreciation
is there a income tax account in a partnership? why or why not?
nah cause partnerships don’t pay income taxes
what is the difference between distributions and dividends
corporations pay dividends
partnerships pay distributions
distributions
distributions can take the form of cash or property
reduced from partner’s capital account
what is part of cash flow from operations?
net income
depreciation and amortization
change in working capital (short term assets and liabilities)
how does an increase in short term assets affect cash flow from operations?
it reduces cash flow from operations cause its like a use of cash
how does an increase in short term liabilities affect cash flow from operations?
it increases cash flow from operations cause its like you got cash (that you owe after)
what is part of cash flows from investments?
change in long term assets (like buying more properties or selling them)
capital expenditures (major repairs) and tenant allowances
what is part of cash flows from financing?
change in long-term liabilities (debt you owe)
changes in equity (people investing in you)
what are funds from operations?
same thing as cash flow from operations, so funds from operations is created (FFO)
it is a cash flow metric
what is the adjusted funds from operations (AFFO)?
also known as fund available for distribution
includes non-revenue generating major capital expenditures such as major repairs
analysts believe its the true depreciation expense
what are the necessary coverage ratios to know?
fixed charge coverage ratio
dividend coverage ratio
fixed charge coverage ratio
the ability of an entity’s income stream to pay for its fixed charges, such as interests and principal payments due on long-term liabilities
(earnings before interests, tax, depredation, and amortization) / (interest expense + periodic principal amortization)
dividend coverage ratio
ability of a real estate enterprise to pay out distributions to investors
FAD / dividends paid
what does a higher fixed charge coverage ratio mean?
the entity will better be able to manage its debt load
what does a higher dividend coverage ratio mean?
the enterprise will be able to maintain or increase its dividends
income taxes
taxes paid on income earned from trade or business
taxes due on sale
when a property is sold, government taxes any property made on the sale
profit = sale price - adjusted basis
what is a basis price?
purchase price for a property and anything paid in transactions is considered a basis
any improvements or anything paid to improve to property become part of the adjusted basis
depreciation lowers the adjusted price
what is the recapture tax?
if the property sells for more than the adjusted basis price, part of depreciation is recaptured and is subject to recapture tax
capital gains tax?
taxes made on the profits if the property sells for more than adjusted basis
only for capital gains of a property held over a year
if sold in less than one year, will be subject to ordinary income tax
use and occupancy tax
charge tax on users of real property for allowing them to use and occupy the asset
property tax
taxes based on percentage pf value of the asset
paid in installments over the course of each year
transfer taxes
tax on the transfer of ownership of asset
deed and mortgage recording taxes
tax for recording the ownership of a property on the local register of deeds
tax for recording the lien of a secured creditor against a property
by maintaining these records, government affords owner and lender certain rights and protections
how can tax deferrals motivate people to invest in RE?
it may encourage owners to hold assets longer
they will be happy to know they will pay less taxes
what are types of tax deferrals?
refinance vs sale
exchange vs sale
contribution to tenants in common vehicle
contribution to real estate investment trust
