What are the two types of real estate investment categories?
-real property assets
-real estate securities
Brokers and salespersons should always refer a potential real estate investor to a competent tax accountant, attorney, and/or investment specialist who can give expert, specific advice.
true
The NAR website (realtor.org) provides excellent resources for agents who want to explore investments.
true
What are tax shelters?
-a real estate investment benefit
-a legal means by which an investor may reduce or defer payment of part of her federal income tax.
Pros and cons of real estate investment
PROS:
-tax shelters
-good rate of return
-can borrow money for investment
-equity buildup
CONS:
-loss of return
-not highly liquidable over a short period
-managment
-costly
What is appreciation of a property? What are the two main factors that affect appreciation?
-when a property increases in value and show a profit when sold at some future date
-Two main factors:
--inflation; increase in the amount of money in circulation which results in a decline in its value coupled with a rise in wholesale and retail prices
--Intrinsic value; the result of individual choice and preference for a given geographic area, based on features and amenities.
A property located in a well-kept suburb near a shopping center has a greater ____________ to most people than similar property located near a sewage treatment plant.
intrinsic value; same house different locations
An investment of agricultural or undeveloped/raw land carry many inherent risks because the property's intrinsic value and potential for appreciation are not easy to determine.
What are the four main questions an investor for land to ask?
intrinsic value and potential for appreciation are not easy to determine
-How fast will the area develop?
-Will it grow sufficiently to make a good profit?
-Will the expected growth even occur?
-Will the profits eventually realized from the property be enough to offset the costs of holding the land?
What are the pros and cons of investing in agricultural or undeveloped/raw land?
PROS:
-very low maintenance; does not wear out
-a good inflation hedge if held for the long term
-can generate income to offset holding costs; leasing to farms, timber production, recreational; hunting and fishing
CONS:
-land does not wear out, IRS does not permit an allowance for depreciation of land on an income tax return.
-limited liquidity; few are willing to purchase land on short notice
-intrisic value and potential for appreciation are hard to determine
The value of land purchased for appreciation must appreciate at a rate great enough to compensate the owner for the cost of holding it.
true
Cash flow is the total amount of money remaining after all expenditures have been paid, including taxes, operating costs, and mortgage payments. What three factores determine the production of cash flow on an investment property?
1. amount of rent received
2. operating expenses
3. method of debt repayment; mortgage
The amount of rent (income) that a property can command depends on what factors?
-location
-physical appearance, and
-amenities
What are operating expenses of an investment property?
-general maintenance of the building
-repairs
-utilites
-taxes, and
-tenant services; security systems
High mortgage payment over a short period will result in a higher cash flow.
false; low mortgage payment over a long period of time will result in a higher cash flow because they allow the investor to retain more income each month
Cash flow can be controlled through the use of various management techniques, such as...
obtaining high temporary rents through short-term leases or postponing minor repairs to generate a higher cash flow for any given period
What is leverage?
-the use of borrowed money to finance the bulk of an investment
What is equity? What two ways influence equity buildup?
the property's market value minus any debts
-the amount of principle payment made each month
-any gain in property value due to appreciation
What is pyramiding?
-when an investor refinances his/her existing real estate holdings and using those proceeds to buy additional properties.
**Under some economic conditions, lending institutions will not make loans against the equity in investment properties. In these cases, equity is not available to the investor until the property is sold. Then, the proceeds will be subject to capital gains taxes and the profit tends to be eroded.
A __________ is defined as the difference between the adjusted basis of property and its selling price.
capital investment
For calculating capital gain, the basis and adjusted basis, along with closing costs have to be subtracted from the selling price. What is the basis and adjusted basis?
Basis: the investor's initial cost for the real estate; purchase cost
Adjusted basis: the basis plus the cost of physical improvements and minus depreciation claimed as a tax deduction.
An investor purchased for $45,000 a single-family dwelling for use as a rental property. The investor is now selling the property for $100,000. Shortly before the sale date, the investor made $3,000 worth of capital improvements to the home. Depreciation of $10,000 on the property improvements has been taken during the term of the investor's ownership. The investor will pay a broker's commission of 7 percent of the sales price and will also pay closing costs of $600. Label the basis and adjusted basis. What is the total capital gain?
Selling price: $100,000
7% commission $7,000
closing costs: + $600
$7,600
$100,000
- $7,600
$92,400 net sales price
Basis:
Original cost $45,000
Improvements + $3,000 $48,000
Depreciation -10,000
Adjusted basis $38,000
$92,400
adjusted basis -$38,000
total capital gain: $ 54, 400
All capital gains on investment real estate are considered taxable.
true
If you are going to do a lot of real estate investing, it is a good idea to get a
real estate attorney
Capital gains tax rates are modified by the American Taxpayer Relief Act.
If a tax payer is in the 10% and 15% tax rage how much is taxed on the appreciation of an investment property?
If a taxpayer is in the 25%, 28%, 33% or 35% tax rage how much is taxed on the appreciation of an investment property?
If a taxpayer is in the 39.6% tax range who much is taxed on the appreciation of an investment property?
0% for 10% to 15%
15% for 25, 28, 33 or 35%
20% for 39.6%
What is an installment sale? What are the benefits of this type of sale?
-the seller receives payments in installments and pays income tax each year based on the amount received during the year.
-an investor may defer federal income tax on a gain by taking payments of the sale instead of one lump sum.
-the gain may be subject to a lower tax rate
Part of the tax can be defferred under what type of sale?
installment sale; accepting payments of sale rather than one lump sum.
Some benefits of an installment sale is that the seller can accept a small cash down payment and thus expand the market of potential buyers. Also the seller can position to negotiate a higher sales price.
true
What is 1031 exchange?
when an investor uses the capital gains from selling a property towards another property with equal or greater value
Capital gains are usually taxed at 15%
true
1031 exchange deferred tax
when the investor uses the capital gains from selling a property towards another property, paying taxes are deferred (don't have to pay at that time), but if the investor decides to sell everything and just collect the cash without reinvesting, the investor has to pay back all the taxes
-idea of 1031 exchange is to keep rolling the investment until you pass away
What is the roll of a qualified intermediary (Q.I.) in a 1031 exchange?
middle-man throughout the process of a 1031 exchange; explain to them what you want and your plans
-DO NOT shop around for the cheapest QI
What are the two key time frames an investor must keep track of with a 1031 exchange?
-the investor has 45 days from the date he/she sold their property to find another property
-once an investor finds another property to invest in, the investor has 180 days to close on that property
If an investor does not make the time frame of 45 days to find a property or 180 days to close, they have too, no matter what reason, pay the taxes owed.
true
Within the 45 day time period of the 1031 exchange plan, what are the three common options to reinvest?
1. Three-Property Rule; find three properties at any price; most common
2. The 200% Rule: find an unlimited amount of properties but they can total no more than 200% of what you just sold your property for; ex, sold property for $2 million, cannot go over $4 million.
3. The 95% Closing Rule; pick out as many properties as you want and there is no price limit, investor must close on 95% of them
The seller can handle the money during a 1031 exchange.
false; if a seller handles the money during the 1031 exchange it is taxed, this is where the QI comes in, they act as the trust for the funds and handle the exchange of funds
Do you pay taxes on your primary residences if you sell it?
NO, unless it is sold over $250,000 if you are single or $500,000 for married
Reverse 1031 exchange
investor buys an investor property first, then sells the other investor property
-more expenses and riskier than the regular 1031 exchange; must find a buyer to close on your property within 180 days
Property purchused in E.A.T. ; exchange accommodation titleholder
What taxes will an investor get hit with if they decide to just sell and not reinvest their investment property?
-capital gains tax 15%
-depreciation recapture tax; if you claim depreciation on that property
-local or state additional taxes; california 3.9%
-If you make over $250,000/yr; ObamaCare Tax 3.8%
Tax deferred means tax free.
false; you still have to pay taxes if you decide not to reinvest
With the 1031 exchange properties have to be greater than or equal to, in order to exchange.
true
With a 1031 exchange it is recommended to not sell or exchange before a ___ year period.
two
From an investment point of view, investment property depreciates, like how business equipment depreciates. Every year the investor can deduct the depreciation from annual taxes. To find the amount to deduct the investor would divide the amount he/she paid for the property by the recovery period. For residential property the recovery period is what? For non residential property (offices, etc), the recovery period is what?
27½ years residential
39 years non-residential
The TRA '86 law (Tax Reform Act of 1986) limits the deductibility of losses from rental (investment) property. If you make under $100,000 you can deduct up to _______ yearly.
If you make over 100,000, what happens with the deductions?
under $100,000; deduct up to $25,000
If you make over $100,000, each dollar over drops off 50 cents less per dollar; $150,000 and above you cannot deduct.
What is a tax credit?
-a different type of tax deduction, that is a direct reduction in tax due, rather than a deduction from income on which tax is computed; has a far greater value than a tax deduction.
-investors in older building renovations/historic properties and low-income housing projects may use designed tax credits to offset tax on a portion of other income.
***MAJOR exception to this rule, requiring active participation in the project.
What is a syndicate? (sin-di-kit)
a group of corporations working for a common interest.
A real estate investment syndicate is what?
-a business venture in which a group of people pools its resources to own and/or develop a particular piece of property.
A syndicate investor enjoys the same federal income tax advantages as a direct ownership real estate investor.
true
Syndicate interests are easy to sell.
false; hard to sell:
-not plain real estate
-may have to get approval from the syndicate's management, which may require that the investor sell her interest to another member of the syndicate
Syndicate participation can take on may different legal forms.
true; tenancy in common, various kinds of partnerships, corporations, and trusts
-private syndication; involves a small group of closely associated and/or widely experienced investors
-public syndication; involves a larger group of investors who may or may not be knowledgeable about the real estate investment
-similar to stocks
Federal securities laws include provisions to control and regulate the offering and sale of securities to protect members of the public who are not sophisticated investors. State laws, aka blue-sky laws protect investors against securities frauds by doing what?
-protect investors against securities frauds by requiring sellers of new issues to register their offerings and provide financial details
Real estate securities don't have to be registered with state officials and/or with the federal Securities & Exchange Commission (SEC).
false; they have to be registered
Real estate investment syndicates are organized in three different forms. What are they?
-general partnership; all members of the group share equally in the managerial decisions, profits, and losses involved with the investment; they designate their own trustee, which is part of the group, aka general partner; the other members of the partnership are passive investors with no voice in the organization and direction of the operation, aka limited partners; share in the profits, and they compensate the general partner; each member stand to lose only what they have invested, nothing more; general partners are totally responsible
-Limited liability partnership; protects individual partners from liability for debts and obligations of the partnership arising from errors, omissions, negligence, and incompetence on the part of one partner--unless there is knowledge of the misconduct at the time of the occurrence.
-Limited partnership; one party(parties), usually a property developer or real estate broker, organizes, operates, and is responsible for the entire syndicate
A ____________________ is a security that is invested in real estate directly, either through properties or mortgages.
real estate investment trust (REIT) similar to a mutual fund except investment is made in properties or mortgages.
Real estate investment trust (REIT) has the same tax benefits as a mutual fund; does not have to pay corporate income tax as long as...
-90% of its income is distributed to its shareholders,
-100 or more members hold shares in the trust and that 75% of the REIT's assets must be invested in real estate, other REITs, securities, and hybrid REITs.
What are the three types of REITs?
-Equity REITs; pool an assortment of large-scale income properties and sell shares to investors.
-Mortgage REITs; operate similar to equity REITs except mortgage REITs buy and sell real estate mortgages rather than real property.
-Hybrid REITs; invest shareholders' funds in both real estate assets and mortgage loans; better; handle economic changes better
What is a real estate mortgage investment conduit (REMIC)?
-a tax device that allows cash flows from an underlying block of commercial mortgages to be passed through to security holders without being subject to income taxes at the level of trustee or agent.
When an investor purchases a parcel of real estate through the use of borrowed funds, she is taking advantage of...
leverage
An investment syndicate in which all members share equally in the managerial decisions, profits, and losses involved in the venture is an example of a general partnership.
true
Inflation
the increase of money in circulation coupled with a rise in prices, resulting in a decline in the value of money.
For both income and appreciation purposes, Mary is contemplating the purchase of an apartment building as an investment at a price of $150,000. All else being equal, which choice should yield Mary the largest percentage of return on her initial investment after the first year?
a. Mary pays $150,000 cash for the property
b. Mary gives the seller $15,000 down and obtains a 30-year mortgage for the balance at 12% interest.
c. Mary gives the seller $20,000 down and agrees to pay the seller 10% of the unpaid balance each year for 10 years, plus 11%.
b
For tax purposes, the initial cost of an investment property, plus the cost of any subsequent improvements to the property, less the amount of any depreciation claimed as a tax deduction, represents the investment's...
adjusted basis
Julia is exchanging her apartment building for an apartment building of greater market value and must include a $10,000 boot to even out the exchange. Which of the following may she use as a boot?
a. $10,000 cash
b. Common stock with a current market value of $10,000
c. An automobile with a current market value of $10,000
d. Any of the above if acceptable to the exchangers
d
A property's equity represents its current value less...
mortgage indebtedness
Barney sold his four-unit apartment building and purchased a six-unit building of the same market value. The gain on the sale of his four-unit apartment building is $28,000. This gain
a. will not be taxed, because Barney exchanged properties
b. will be taxed
c. will be amortized over 27½ years.
d. is called net debt relief
b
In an installment sale, taxable gain is received and must be reported as income by the seller in each year...
that installment payments are received
When investors hold ad refinance investment properties, using their equities as leverage, they are taking advantage of which concept?
pyramiding
A small multifamily property generates $50,000 in rental income with expenses of $45,000 annually, including $35,000 in debt service. The property appreciates about $25,000 a year. On this property the cash flow is...
$5,000
Shareholders in a real estate investment trust generally receive most of the trust's income each year.
