Real Estate Investment Flashcards

Questions and Answers

What is a tax-deferred exchange?

Exchanging properties with identical values

A method to defer paying taxes on the sale of a property (correct)

Selling a property and buying another within 180 days

Retaining the property received from another owner

In a delayed exchange, the property owner can find a buyer for the relinquished property before finding the replacement property.

True

What must a third-party qualified intermediary do in a delayed exchange?

Hold the cash from the sale

The exchangor must designate the property to be acquired within _____ days of closing the sale.

45 Signup and view all the answers

The purchase of the designated property must be completed within _____ days after closing on the sale of the relinquished property.

180 Signup and view all the answers

What is the main tax implication of installment sales?

Tax is only paid on the profit portion of each payment received. Signup and view all the answers

What is considered ordinary income in installment sales?

Interest received on payments Signup and view all the answers

What does liquidity refer to in real estate?

Liquidity refers to how quickly an asset can be converted into cash. Real estate is not a liquid asset. Signup and view all the answers

Which of the following are disadvantages of real estate? (Select all that apply)

Sweat equity may be required Signup and view all the answers

What is one of the advantages of real estate investment?

Appreciation Signup and view all the answers

What is the definition of inflation?

Inflation is the increase in the amount of money in circulation, causing the value of money to decline. Signup and view all the answers

What is the term used for using one property to acquire additional properties?

Pyramiding Signup and view all the answers

What is debt service?

Debt service refers to the amount paid for the principal and interest payments on mortgage loans. Signup and view all the answers

According to the IRS, which type of income includes wages, salaries, tips, and interest income?

Ordinary income Signup and view all the answers

What is capital gains tax?

Capital gains tax is the tax on the profit made from selling a property for more than its purchase price. Signup and view all the answers

What is the current maximum short-term capital gains tax rate?

39.6% Signup and view all the answers

What is the basis in real estate?

The basis is the initial price paid for the real estate, which can change over time due to capital improvements. Signup and view all the answers

What do homeowners generally deduct from their gross income?

Homeowners may deduct mortgage interest payments, real estate taxes, certain loan origination fees, and others. Signup and view all the answers

What is one condition for a taxpayer to qualify for the exclusion of capital gains under the Taxpayer Relief Act of 1997?

The homeowner must use the home as a principal residence for at least 2 of the last 5 years. Signup and view all the answers

What is a tax credit?

A tax credit is a direct reduction in the tax due rather than a deduction from income. Signup and view all the answers

What is required for a property exchange to defer capital gains tax under IRC Section 1031?

The property exchanged must be of like kind. Signup and view all the answers

Study Notes

Real Estate Investment Basics

Liquidity: The speed at which an asset can be turned into cash. Real estate is characterized as a non-liquid asset.

Disadvantages of Real Estate Investment

Lack of liquidity compared to stocks and bonds.
High expenses associated with investment, including purchase and maintenance.
Requires active management, with potential need for sweat equity.
Poor management can lead to unsuccessful investments.
Real estate investments carry inherent risks.

Advantages of Real Estate Investment

Potential for appreciation value over time.

Factors Affecting Appreciation

Inflation: Increased money supply leads to decreased value and rising prices due to supply and demand dynamics.
Intrinsic Value: A property’s worth is influenced by personal preferences for location and amenities; desirable locations command higher prices.

Rates of Return and Leverage

Real estate investments can yield returns exceeding mortgage interest rates.
Investors may utilize borrowed funds, but higher leverage increases financial risk.
Market downturns can cause cash flow issues for highly leveraged properties.

Pyramiding

A method of acquiring additional properties using the equity from existing real estate holdings.
Pyramiding can occur through property sales or refinancing operations.

Cash Flow

The primary goal of income property investments is to achieve positive cash flow, which is the profit after all expenses.

Debt Service

The total payments made for principal and interest on mortgage loans.

Tax Reform Act of 1986

Established limits on tax write-offs for losses from passive investments, changing prior tax advantage dynamics for real estate investors.

Classifications of Income by IRS

Ordinary Income: Includes wages, salaries, and interest.
Portfolio Income: Includes dividends from stocks and bonds.
Passive Investment Income: Includes rental income from non-participatory activities.
Capital Gains: Profits from selling assets above their purchase price.

Capital Gains

Taxable profits from selling property at a higher price than purchased; preferred treatment for long-term investments.

Basis in Real Estate

The original purchase price of a property, which can increase due to capital improvements and related costs.

Capital Improvements

Permanent enhancements that increase property value, such as major renovations.

Short and Long Term Capital Gains Tax Rates

Short-term capital gains tax equals ordinary income tax rates.
Long-term capital gains tax varies based on income levels, with specific brackets set for single and married taxpayers.

Capital Gains Tax Calculation

Formula: Original cost + capital improvements - depreciation = adjusted basis.
Net selling price - adjusted basis = capital gain.

Example Calculation

Example shows a capital gain of $11,675 from a sale of a rental property after accounting for basis and expenses.

Depreciation

Primarily, straight-line depreciation is allowed; useful life spans set at 27.5 years for residential and 39 years for non-residential properties.

Tax Classifications for Real Estate

Various classifications include investment properties, personal residences, and properties held for business.

Tax Implications for Different Real Estate Types

Investment properties treat profits as capital gains and allow for deductions on depreciation and expenses.
Personal residences have limitations on losses and allow for certain deductions only.

Real Estate Held for Resale

Properties classified as inventory are subject to ordinary income treatment upon sale.

Passive Investors

Defined as those who do not actively engage in the management of their real estate assets.

Tax Credits

Direct reductions in tax liability encouraging redevelopment and low-income housing creation.

Deductions for Homeowners

Homeowners can deduct mortgage interest, real estate taxes, certain fees, and penalties from gross income.

Principal Residence Exclusion

Homeowners can exclude up to $250,000 in gains ($500,000 for couples) from taxes when selling their principal residence, subject to specific criteria.

Tax Deferred Exchanges

Allow deferral of capital gains taxes when exchanging properties of like kind, with stringent adherence to IRS rules.

Installment Sales

Taxation occurs on a portion of each payment received when selling property on an installment basis, treating interest as ordinary income.

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Description

Test your knowledge on essential terms related to real estate investment with these flashcards. Learn about concepts like liquidity and the disadvantages of investing in real estate. This quiz is perfect for anyone looking to deepen their understanding of real estate as an investment.