Tax Impacts in Mortgage Lending

Question 1

What is a property’s initial tax basis?

Answer 1

Everything of value that was given in exchange for the property, including any commissions, legal fees, title insurance and other items that the purchaser had to pay to complete the purchase that are not deductible as a current operating expense.

Question 2

Define depreciation allowance

Answer 2

An amount an investor can deduct from his or her taxable income to recover some of his or her investment capital.

Question 3

Glenda purchased a nonresidential building in June 2004. Her initial tax basis on the building is $480,500. What is her monthly depreciation allowance?

Answer 3

$480,500 ÷ (12 X 39) = $480,500 ÷ 468 = $1,026.71

Remember: Nonresidential buildings have a cost recovery period of 39 years.

Question 4

What kind of circumstance would decrease the tax basis of a property and what type of circumstance would increase the basis?

Answer 4

Damage to the property would result in a decrease in the tax basis, while money spent to increase the property’s value or useful life would increase the tax basis.

Question 5

What is the most important consideration when choosing an investment ownership type?

Answer 5

Maintaining decision-making control over the operations

Question 6

Under what circumstances would the joint tenancy form of ownership be a bad idea?

Answer 6

Because of the right of survivorship, joint tenancy is not a good idea unless the other joint tenant or tenants are people to whom the investor intended to leave the property to anyway.

Question 7

Explain the difference between a tax deduction and a tax credit.

Answer 7

A tax deduction reduces a person’s taxable income. A tax credit reduces the actual tax liability dollar for dollar, after the tax due amount has been computed.

Question 8

What does the Foreign Investment Real Property Tax Act of 1980 require?

Answer 8

The act requires that any person who purchases property from a seller who is not a US citizen must withhold and send to the IRS 10% of the gross sales price.

Question 9

Explain the difference between realized and recognized gains or losses.

Answer 9

A gain or loss is realized at the time the property or asset is sold.

A recognized gain or loss is the amount incurred that must be reported on income taxes for a specific year (either the year of the transaction or later) and is determined by how the transaction is structured.

Question 10

Which kinds of assets are considered Section 1231 assets and which are not?

Answer 10

Assets used in a trade or business are Section 1231 assets.

Assets held for investments or personal use are not Section 1231 assets.

Question 11

What is the potential important advantage to a seller who uses the installment sales method when selling a property?

Answer 11

The seller may be able to defer the taxes on the gain until he or she is in a lower tax bracket.

Question 12

What is the definition of a like-kind exchange?

Answer 12

One property can be exchanged for another property regardless of the property type, as long as it is held as an investment or for use in a trade or business.

Question 13

An investor’s tax basis in a property

Answer 13

is of major significance to the outcome of the investment. From the time a property is first purchased, owners have a tax basis in the property. Selling or exchanging a property generates a gain or loss equal to the difference between the sales price and the adjusted basis of the property at the time it is sold.

Question 14

The initial basis in property that is purchased is

Answer 14

what it cost to make the purchase, including any commissions, legal fees, title insurance and other items that the purchaser had to pay to complete the purchase that are not deductible as a current operating expense.

Question 15

If a buyer purchases two or more assets in a single transaction

Answer 15

the initial tax basis must be distributed among them according to their relative market values.

Question 16

An investor can deduct an allowance from otherwise taxable income to recover some of his or her investment capital.

Answer 16

The allowance is called a depreciation allowance. Only assets held for business or income purposes are eligible for the depreciation allowance. However, eligibility for the allowance is determined by the intent to produce income, rather than actually producing it.

Question 17

The recovery period for qualifying residential structures is

Answer 17

27.5 Years

Question 18

The recovery period for nonresidential buildings purchased after May 12, 1993

Answer 18

39 Years

Question 19

The recovery period for land improvements, such as walks, roads, sewers, gutters, and fences, is

Answer 19

15 Years

Question 20

An investor recovers the tax basis of a building

Answer 20

in equal annual increments over the allowable recovery period.

Question 21

When a property sells or is damaged or destroyed by a disaster such as a fire, flood or storm,

Answer 21

the tax basis is reduced

Question 22

Investors have a variety of ownership entity choices. These ownership forms include ownership by:

Answer 22

Individuals
Corporations
Subchapter S Corporations
General Partnerships
Limited Partnerships
Limited Liability Companies

Question 23

The chief consideration when choosing an ownership type is the importance of

Answer 23

maintaining decision-making control over operational matters.

Question 24

Ownership by one individual is known as

Answer 24

tenancy in severalty

Question 25

The most common co-tenancy arrangements are

Answer 25

tenancy in common and joint tenancy.

Question 26

Even though there appears to be several disadvantages to holding title as a corporation, corporations do offer several advantages. These are the most important.

Answer 26

Limited shareholder liability
Liquidity
Easier transactions
Easier estate settlement

Question 27

Unlike corporations, partnerships are

Answer 27

not taxable entities

Question 28

A limited liability company, LLC

Answer 28

gives investors the income tax advantage of a partnership and the limited liability benefits of a corporation.

Question 29

When an investor borrows or repays money, his or her tax liability is

Answer 29

neither increased nor decreased. However, the interest on money borrowed for rental real estate is usually deductible in the taxable year that it is paid.

Question 30

Costs to renovate low-income housing or special nonresidential properties qualify for tax credits rather than tax deductions

Answer 30

Tax credits are not the same as tax deductions. Tax credits give a dollar-for-dollar reduction in tax liability which is subtracted from the total tax due after the amount of income tax has been computed.

Question 31

Limited partners’ income and expenses

Answer 31

are always passive

Question 32

Real estate rental income and expenses are

Answer 32

sometimes passive

Question 33

The Alternative Minimum Tax is a modified “flat-rate” tax that coexists within the regular income tax system

Answer 33

After a taxpayer figures his or her taxable income and how much he or she owes in income tax using the regular process for computing tax, he or she must compute an alternative minimum taxable income and alternative minimum tax. After both computations are done, the taxpayer must pay the larger of the alternative tax or the regular tax.

Question 34

The tax consequences of selling property

Answer 34

depend in part on the amount and nature of the gain or loss and how the transaction is structured.

Question 35

The realized gain or loss on a transaction is

Answer 35

the difference between the consideration received and the adjusted tax basis at the time the transaction takes place.

Question 36

Realized gain

Answer 36

may be treated as ordinary income or as capital gain

Question 37

Capital gain

Answer 37

gets special tax treatment. By the same token, a loss may result in a decrease in ordinary income taxable for the year, or it may be a capital loss and be able to offset ordinary taxable income by only a limited amount.

Question 38

If a transaction is a cash sale and the seller realizes a gain

Answer 38

that gain will be recognized in the year of the transaction. However, if the sale results in a loss, a portion of it may have to be carried forward and recognized in future taxable years.

Question 39

When a seller sells a property and gets only a partial payment for it during the year of the sale,

Answer 39

he or she can report the transaction under the installment sales method
Using this method allows the seller to defer a part of the income tax liability until he or she collects the balance of the cash.

Question 40

If an investor participates in an exchange of a like-kind asset,

Answer 40

any taxable gain or tax-deductible loss is not recognized in the year the transaction takes place. Instead, the investor can defer those gains or losses, until a future taxable transaction occurs involving a substitute property. The legislation that deals with like-kind exchanges is contained in Section 1031 of the IRS code. Because of this, these exchanges are sometimes called Section 1031 exchanges.

Question 41

To qualify as a like-kind exchange, the property being transferred must have been held for

Answer 41

productive use in a trade or business or held as an investment and must be exchanged for property that will also be used in a trade or business or be held as an investment.

Question 42

If a person owns a property free and clear and gives the property to someone else, no money or other payment changes hands in the transaction

Answer 42

so there is no realized gain or loss. However there may be a gift tax. Taxpayers can give up to $14,000 per person per year to as many people as they want to without having to pay a gift tax. If spouses jointly make gifts, they are permitted to give up to $28,000 per person per year without having to pay the gift tax.