Income Tax in Real Estate Transactions Flashcards
Taxpayer Relief Act of 1997
It reduced several federal taxes in the US. Subject to certain phase-in rules, the top capital gains rates fell from 28% to 20%. The 15% bracket was lowered to 10%
- The profits from the sale of a personal residence were exempt (only for residences that the person has lived in for 2 years within 5 year span. Eligible for the $500,000 exemption)
- Use of IRA funds toward down-payment without early withdraw penalty (up to $10,000,000) (still have to pay the income taxes on it) for first time homeowners
Permitted Deductions
PROPERTY TAX
- personal residences
- second home
- time share
- vacant land
- inherited property
- (Property taxes on non-investment properties can only be deducted if one’s taxes are itemized)
MORTGAGE INTEREST
- Must file for 1040
- Mule file Schedule A
- The tax payer must be legally liable for the loan
- Primary Home/Secondary Home
- Acquisition debt or refinancing capital
- Construction/Home improvement
- Line of credit
- Home equity loan
Mortgage
An instrument in writing, duly executed and delivered, that creates a lien upon real estate as security for the payment of a specified debt, which is usually in the form of a bond
-Subject to certain limitations, mortgage interest is deductible on a primary residence and a secondary home
DHCR
New York State Division of Housing and Community Renewal, a New York State administrative agency which regulates residential housing subject to rent stabilization and rent control (lead housing credit agency for NY that oversees the LIHC)
Low Income Housing Incentives
- LIHC
- promote private sector involvement
- dollar for dollar reduction for project owners who develops rental housing for low income households
Tax Reform Act of 1986
- Established LIHC (Low income housing credit program)
- Lowered the top tax rate from 50% to 28% and raised the bottom tax rate from 11% to 15%
- Low income may be considered a household income that is 60% or less of the average (median) area household income in that year (income adjusted for household size)
- promote private sector involvement
- dollar for dollar reduction for project owners who develops rental housing for low income households
Medical Surtax
The 3.8% tax on new investment income applies to individuals, estates, and certain trusts who have modified adjusted gross income in excess of:
- $250,000in the case of married tax payers filing a joint return or a surviving spouse;
- $125,000 in the case of a married taxpayer filing separately,
- $200,000 for everyone else except estates and trusts
The 0.9% Additional Medicare tax applies to individuals at the same threshold amounts, but does not apply to estates or trusts.
(in Jan 2013 over 50% increase)
Straight-line Depreciation (Economic depreciation)
A method of calculating the depreciation of an asset which assumes the asset will lose an equal amount of value each year.
-Results from the physical deterioration of a property while you’re owning it
Component Depreciation (Cost segregation)
The difference between a lower selling price and a higher purchase price, resulting in a financial loss to the seller. For tax purposes, allocating a portion of the total cost of renovation to each component of the renovation (roof, plumbing, electrical, foundation, etc) and then depreciating the cost of each component separately
- accelerating depreciation deductions
- getting most benefit out of depreciation
Component Depreciation
The difference between a lower selling price and a higher purchase price, resulting in a financial loss to the seller. For tax purposes, allocating a portion of the total cost of renovation to each component of the renovation (roof, plumbing, electrical, foundation, etc)
- This means of depreciation breaks down a property into various components and then determines the depreciation on each component separately
- Real estate investors will most likely benefit most from this type of depreciation
Depreciation
A loss of utility and thus value caused by physical deterioration, functional obsolescence or economic obsolescence or any combination thereof
- Economic depreciation is relevant to real estate
- Cost recovery concept: period expensing of an asset over the property’s theoretical economic life
- Offsets operating income
- not a cash item - reducing taxable income year to year without expending actual cash
- friend at ownership, enemy at sale
Tax Credit
dollar for dollar reduction in the taxes you would owe
Tax Deduction
take amount you’re eligible for in the deduction and apply the tax rates = amount you can reduce from tax income
Non-Depreciable Assets
- Personal use assets
- Land (doesn’t ware out over time)
Depreciable Assets
- Buildings
- Equipment
- Machinery (items used in a business to produce income or held for investment)
Straight-line Depreciation Method
–>Income Producing Residential Property- 27.5 years
ex: property depreciable basis: $2,750,000
$2,750,000 / 27.5 = $100,000 (yearly allowable depreciation)
–> Income Producing Non-Residential (Commercial Property) - 39 years
Investors can benefit from depreciation when they own the property but may be a liability when they sell the property
Capital Gain
A profit that results from a the sale of a property where the amount realized from the sale exceed the purchase price.
Capital Loss
The difference between a lower selling price and a higher purchase price, resulting in a financial loss to the seller.
(not deductible again taxable income over $3000)
Income Types
- Operations Income
- Active Income (salaries, business, participation)
- Portfolio Income (dividends, interest, annuities, royalties)
- PASSIVE INCOME (invested funds) can’t deduct, can’t offset again portfolio or active income
2. Capital Gains SHORT-TERM -Asset is held for less than 12 months -Ordinary income tax rate LONG-TERM -Asset is held for more than 12 months -Long-term capital gains tax rates (approx. 23.5%)
Basis
A major accounting method that recognizes revenues and expenses at the time physical cash is actually received or paid out.
