section 18 real estate investment

Question 1

The degree to which an investment is readily marketable, or convertible to another form of asset. If immediately salable, an investment is liquid; the longer it takes to sell, the more illiquid the investment. Real property is relatively illiquid in comparison with other types of investment.

Answer 1

Liquidity

Question 2

You may pledge the value of your resource to borrow funds in order to make an investment that is larger than your own resource permits you to do directly. The small resource is used as a lever to make a larger investment, and thus increases your opportunity to benefit from income, appreciation, and the other rewards of investment.

Answer 2

Leverage

Question 3

A residential property used as the investor’s primary residence. The basic reward, beyond the enjoyment of use, comes in the form of appreciation. There may also be tax benefits, depending on how the purchase is financed.

Answer 3

Non-income property:

Question 4

A property owned specifically for the investment rewards it offers. Examples are multi-family residential properties, retail stores, industrial properties, and office buildings. Rewards come in any or all of the forms mentioned earlier: income, appreciation, leverage and tax advantages.

Answer 4

Income Property:

Question 5

The return that an investor could earn on capital invested with minimal risk. If the real estate investment, with all its attendant risk, cannot yield a greater return than an investment elsewhere involving less risk, then the opportunity cost is too high for the real estate investment.

Answer 5

Opportunity Cost:

Question 6

A group of investors who combine resources to buy, develop, and/or operate a property.

Answer 6

Syndicate

Question 7

: A syndicate in which all members participate equally in managing the investment and in the profits or losses it generates. The group designates a trustee to hold title in the name of the syndicate.

Answer 7

General Partnerships:

Question 8

: A syndicate in which a general partner organizes, operates and is generally responsible for the partnership’s interests in the property. Limited partners invest money in the partnership but do not participate in operating the property. These limited partners are passive investors.

Answer 8

Limited Partnerships:

Question 9

(Real Estate Investment Trust). Investors buy certificates in the trust, and the trust in turn invests in mortgages or real estate. Investors receive income according to the number of shares they own. A trust must receive at least 75% of its income from real estate to qualify as a REIT, and if certain other conditions are met, the trust does not have to pay any corporate income tax.

Answer 9

REIT:

Question 10

(Real Estate Mortgage Investment Conduit). A kind of partnership entity formed to hold a fixed pool of mortgages that are secured by real property. The entity issues two kinds of interest. Holders of residual interests are treated, for tax purposes, as partners. Holders of regular interests are regarded as owning debt instruments. Income (or loss) received by regular or residual interest holders is treated as portfolio income or loss, and is not included in determining losses from passive activities.

Answer 10

REMIC:

Question 11

Allows the owner of income property to deduct a portion of the property’s value from gross income each year over the life of the asset. The “life of the asset” and the deductible portion are defined by law.

Answer 11

Cost Recovery:

Question 12

When real estate, whether non-income or income, is sold, a taxable event occurs. If the sale proceeds exceed the original cost of the investment, subject to some adjustments, there is a capital gain that is subject to tax.

Answer 12

Capital Gain:

Question 13

Business activities in which the taxpayer does not materially participate. Included are interests in limited partnerships and rental activities.

Answer 13

Passive Activity:

Question 14

The increase in value of an asset over time.

An increase in the value of a property generally owing to economic forces beyond the control of the owner.

Answer 14

Appreciation

Question 15

The beginning basis, or cost, of a property plus the costs of capital improvements, minus all depreciation expense.

The basic formula for adjusted basis is:
Beginning basis
+ capital improvements
- exclusions, credits or other amounts received
adjusted basis

Answer 15

Adjusted Basis:

Question 16

The gain on sale of a primary residence is represented by the basic formula:

amount realized (net sales proceeds)
- adjusted basis
gain on sale

Gain on sale, if it does not qualify for an exclusion under current tax law, is taxable.

Answer 16

Gain on Sale:

Question 17

The remaining positive or negative amount of income an investment produces after subtracting all operating expenses and debt service from gross income.

Answer 17

Cash Flow:

Question 18

The owner’s tax liability on taxable income from the property is based on taxable income rather than cash flow. Taxable income and tax liability are calculated as follows:

net operating income (NOI)
+ reserves
- interest expense
- cost recovery expense
= taxable income
x tax rate
= tax liability

Answer 18

Tax Liability:

Question 19

When an investment property generates less income than the amount the investor has to pay a lender to finance the investment, the investor suffers from

Answer 19

negative leverage.

Question 20

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 20

direct investment.

Question 21

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

Investors are partners in an entity that sells pools of mortgages secured by real property.

Investors are general partners who pool cash resources to buy, develop and operate a property.

Owners of an income property convey title in the property to a land trust as a tax shield.

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

Answer 21

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

Question 22

Cost recovery is allowed as a federal tax deduction on

Answer 22

income properties.

Question 23

A homeowner paid $185,000 for a house three years ago. The house sells today for $239,000. How much has the property appreciated?

Answer 23

29 %.

Question 24

The primary tax benefit in owning a non-income property such as a residence is

Answer 24

a deduction for mortgage interest.

Question 25

A house sold for $150,000. The seller paid a brokerage commission of six percent, legal fees of $600, and had other closing costs of $1,500. What are the net proceeds from the sale?

Answer 25

$138,900.

Question 26

A homeowner bought a house five years ago for $150,000. Since then, the homeowner has spent $3,000 to pave the driveway and has added a central heating/air conditioning system at a cost of $4,000. What is the homeowner’s adjusted basis if the house is sold today?

Answer 26

$157,000.

Question 27

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 27

$15,000.

Question 28

After three years of owner-occupancy, a young homeowner sells his principal residence for a gain of $150,000, and the next month buys another principal residence that costs more than the adjusted sale price of the old home. Which of the following is true of the treatment of the tax on gain?

Answer 28

There is no taxable gain.

Question 29

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

The seller is 55 years old, the property is used as a principal residence, and the seller’s previously claimed exclusions do not exceed $125,000.

The property is owner-occupied and the seller has never claimed an exclusion previously.

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.

The seller must have owned and occupied it for five years and not claimed an exclusion in the previous year.

Answer 29

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 30

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 30%. What is the tax liability for the year?

Answer 30

$2,100.

Question 31

One way investors measure the yield of an investment is by

Answer 31

dividing cash flow by the investor’s equity.

Question 32

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 32

cost recovery expense.

Question 33

Capital gain tax is figured by multiplying one’s tax bracket times

Answer 33

the difference between net sale proceeds and adjusted basis.

Question 34

An investment property seller pays $14,000 in closing costs. These costs

Answer 34

may be deducted from the sale price for gains tax purposes.