Tax Fundamentals for Real Estate

Learning Objectives

• Students should be able to distinguish between tax deductions and tax credits.
• Students should be able to differentiate between initial basis and adjusted basis.
• Students should be able to explain how to calculate gains, losses, and amounts realized on transactions.
• Students should be able to list real property classifications contained in the tax code.
• Students should be able to name the types of transactions that qualify as nonrecognition transactions.
• Students should be able to describe the types of property that are eligible for tax-free exchanges.
• Students should be able to define the terms "boot" and "debt relief".
• Students should be able to describe circumstances under which a taxpayer may exclude gain on sale of personal residence.
• Students should be able to name at least five types of income tax deductions available to property owners.

Suggested Lesson Plan

• Review previous chapter on closing real estate transactions.
• Overview of Chapter 13 on income taxation and real estate.
• Review learning objectives for the chapter.

Basic Taxation Concepts

• Federal income tax is a progressive tax.
• Income is any economic benefit realized by a taxpayer.
• A deduction is subtracted from income before calculating tax owed.
• Tax code classifies real property into six categories.
• Gains from asset sales are income, but losses may be deductible.
• Taxpayer's basis is initial investment.
• Adjusted basis considers capital expenditures and depreciation deductions.
• A gain is not taxable until realized at the time of sale or exchange.
• Gain is usually recognized in the year of realization.

Nonrecognition Transactions

• Installment sales—less than 100% of sales price received in the sale year.
• Taxes only paid on the portion of profit received in each year..
• Installment sales are for all property types except dealer property.
• Gain is calculated based on the ratio of gross profit to the contract price.
• Involuntary conversions—asset is turned into cash without voluntary action (like damage and insurance proceeds).

Exclusion of Gain from Sale of Principal Residence

• Taxpayers may exclude entire gain on sale of principal residence.
• Up to $250,000 for single filers or $500,000 for joint filers.
• Must have owned and used the property for at least two years of the previous five years to qualify.

Deductions Available to Property Owners

• Property tax deductions—allowed for all types of property.
• Mortgage interest deductions—loans up to $750,000 to buy, build, or improve a residence.
• Deductibility of points and loan costs—prepaid interest deductions.
• Uninsured casualty or theft loss deductions.
• Depreciation deductions.
• Repair deductions—deductible expenses for keeping property in operating condition.
• Deductions from operational losses from rental property.
• Rental payment deductions.

Home Mortgage Interest Deduction

• Federal tax law allows homeowners to deduct interest on loans for buying, building, or improving residence.

Exercise 13.1 Review Exercise

• True or false questions regarding escrow transactions.
• Questions related to escrow, brokers roles, and conditions for closing transactions.

Exercise 13.2 Basic tax concepts

• Review fundamental tax concepts with fill-in-the-blank questions. (Initial basis, adjusted basis, capital gain, tax credit, etc.)

Exercise 13.3 Nonrecognition transactions

• Review details about non-recognition transactions (installment sales, involuntary conversions, and tax-free exchanges)

Exercise 13.4 Home mortgage interest deduction

• Discussion of how federal law allows homeowners to deduct interest on loans for buying, building, or improving a residence.
• Analysis of the policy and fairness to others (like renters).

Chapter 13 Quiz

• Comprehensive multiple choice questions reviewing covered topics.