Question 1

Under certain circumstances, investors are permitted to reduce the amount of the taxable income that they report by an amount that is intended to reflect the wear and tear of an asset over time. This is commonly referred to as:

Accepted Answer

Depreciation is the process of allocating the cost of an asset over its useful life. By reducing taxable income, investors can potentially lower their tax liability. Appreciation refers to an increase in the value of an asset over time, while capital gains and losses refer to the difference between an asset's purchase price and its sale price. Neither of these terms necessarily involves reducing taxable income.

Question 2

For purposes of federal income taxes, real property is classified into four categories. With which of the following types of real estate is the investor able to reduce his taxable income to reflect the wear and tear of a property over time?

Accepted Answer

The investor is able to reduce his taxable income by claiming deductions for depreciation of the property over time. This applies to trade or business property used for the production of income, such as rental properties. Personal residences and dealer property do not qualify for depreciation deductions, while investment property may qualify for depreciation but only to the extent of any income earned from the property.

Question 3

U.S. tax law is designed to raise revenues for the operations of the federal government and to promote certain socially desirable real estate-related activities. Tax legislation is combined into a single section of the federal statutory law commonly referred to as:

Accepted Answer

The Internal Revenue Code is the comprehensive set of tax laws enacted by Congress and is the main source of federal tax law governing activities related to real estate and other areas of taxation.

Question 4

Congressional legislation has repeatedly altered the period of time over which rental real estate may be depreciated. Currently, residential income producing property (e.g. apartments) may be depreciated over no less than:

Accepted Answer

According to current tax laws, residential income producing property such as apartments may be depreciated over 27 ½ years.

Question 5

Since many commercial properties are held by limited liability corporations or limited partnerships, it is important to understand the tax consequences at the individual investor level. Individuals face different tax rates depending on the level of their taxable income. As of 2016, an individual making between $91,151 and $190,150 would fall into which of the following tax brackets?

Accepted Answer

According to the 2016 tax brackets, an individual making between $91,151 and $190,150 would fall into the 28% tax bracket. Therefore, the correct answer is option C.

Question 6

Certain costs associated with a property's upkeep as well as the manner in which it was financed can be depreciated and therefore have a beneficial impact on the tax paid by the investor in a particular year. Which of the following cash outflows is deductible for income tax purposes in the year in which they are made?

Accepted Answer

Operating expenses, such as property taxes, insurance, and maintenance costs, are deductible for income tax purposes in the year in which they are made. Capital expenditures, which are costs associated with improving the property, are not deductible in the year they are made, but rather must be depreciated over time. Up-front financing costs and repayment of principal are also not immediately deductible, but rather must be amortized over the life of the loan.

Question 7

Suppose a taxpayer owns an apartment complex. Under U.S. tax law, in what category would this property be classified?

Accepted Answer

According to U.S tax law, property used in trade or business (such as an apartment complex) is considered a separate category for tax purposes. This means that income and expenses related to the property would be reported on the taxpayer's tax return as business income or expenses. Option A (Personal residence) is incorrect because it refers to property that is primarily used as a personal residence, not as a business property. Option B (Dealer property) is incorrect because it refers to property held by a dealer (such as an auto dealer) for the purpose of resale. Option D (Investment property) is incorrect because it generally refers to property that is held for the purpose of generating income, but not necessarily as part of a trade or business.

Question 8

The direct ownership of commercial real estate produces cash flows from rental operations and, perhaps, cash flow from an eventual sale of the property. Since financial leverage and tax considerations play an important part in determining an investor's returns, the measure of investment value most relevant to investors is the present value of:

Accepted Answer

The measure of investment value that is most relevant to investors is the present value of after-tax cash flows (ATCF), as financial leverage and tax considerations impact an investor's returns. Therefore, ATCF takes into account the effects of financing and taxes on cash flows and provides a more accurate representation of an investment's value to the investor.

Question 9

All taxable income from investment property sales must eventually be classified as either ordinary income, depreciation recapture income, or capital gain income. What is the maximum tax rate that an investor can be charged on depreciation recapture income?

Accepted Answer

The maximum tax rate for depreciation recapture income is currently 25%. This is because depreciation is taxed as ordinary income up to a maximum of 25%, regardless of the investor's income tax bracket.

Question 10

Current tax law allows investors to take tax credits for the cost of renovating or rehabilitating older or historic structures and for the construction or rehabilitation of qualified low-income housing. Which of the following statements regarding tax credits is true?

Accepted Answer

A tax credit directly reduces the investor's tax liability by the same dollar amount as the credit. In contrast, a tax deduction reduces the investor's taxable income, but the actual tax savings depend on the individual's tax bracket. Therefore, a $1 tax credit reduces the investor's tax liability by $1.

Question 11

The value of a property can be thought of as having two components, a land component and a building component. Since the land component of the original cost basis is not depreciable, it is important to understand how much of the property's value is typically attributed to the land for tax purposes. As a general rule, the value of land constitutes what percentage (expressed as a range) of the total value of a commercial property?

Accepted Answer

The value of land typically constitutes 10% to 30% of the total value of a commercial property. This range is used for tax purposes to separate the non-depreciable land component from the depreciable building component.

Question 12

Sharon purchased a new photocopier for her business. According to her accountant, she can deduct 1/7ᵗʰ of its original cost each year for the next seven years from her taxable income. This depreciation method is commonly referred to as:

Accepted Answer

The depreciation method described is the straight line method, as the asset is depreciated evenly over seven years by deducting 1/7ᵗʰ of its original cost each year. The declining balance method, sum of the years' digits method, and modified accelerated cost recovery system are all different methods of depreciation that do not align with the given scenario.

Question 13

The benefit of being classified as a capital gain is that the income is subject to a tax rate that maxes out at 20%, which may be well below the tax rates associated with depreciation recapture income and ordinary income for a particular investor. In order to qualify for the lower capital gain tax rate, the property being sold must be held for more than:

Accepted Answer

To qualify for the lower capital gain tax rate, the property being sold must be held for more than 12 months.

Question 14

When cash flows are classified as passive activity income, investors are subject to passive activity loss restrictions. These restrictions imply that passive income losses:

Accepted Answer

Passive activity loss restrictions allow passive losses to be used only to offset positive taxable income from other passive activities. The losses cannot be used to offset income from other types of activities such as active or portfolio activities.

Question 15

Distinguishing between the four categories of real estate for federal tax purposes can be misleading at times. Which of the following categories includes properties that are held primarily for capital appreciation?

Accepted Answer

Investment property is held primarily for capital appreciation, while personal residences are held for personal use, dealer property is held for sale in the course of a business, and trade or business property is used in the taxpayer's trade or business.

Question 16

The potentially large amount of taxes due on sale of commercial property has caused investors and policy makers to seek ways to defer taxes on the disposition of a property. A popular option has become for investors to swap one eligible property for another in order to avoid or defer capital gains taxes. Which of the following methods for deferring taxes does this describe?

Accepted Answer

This describes a like-kind exchange, also known as a 1031 exchange, where an investor swaps one property for another in order to defer taxes on the sale of the first property.

Question 17

There are three main types of income subject to federal taxation. Which of the following types of income includes income generated from rental real estate investments?

Accepted Answer

Passive activity income includes income generated from rental real estate investments, as well as other passive activities such as limited partnerships and rental properties. Active income refers to income earned from wages or self-employment, while portfolio income includes income from investments such as stocks and bonds. Residual income is not a recognized category of income for tax purposes.

Question 18

In a like-kind exchange, property owners must meet a number of conditions in order to be eligible to take advantage of this tax deferment. One criterion is for the exchange to be between "like-kind" properties. Which of the following exchanges represents an example of an eligible "like-kind" exchange?

Accepted Answer

In order for an exchange to be considered "like-kind," the properties being exchanged must be of the same nature, character, or class. Option A represents a non-like-kind exchange because shares in a publicly traded REIT are not real property. Option B involves exchanging a retail property in one country for a retail property in another country, which is not eligible for like-kind exchange treatment. Option C also involves exchanging real property for a personal residence, which does not qualify for like-kind exchange treatment. Only option D involves exchanging one type of commercial property for another commercial property of the same nature and character within the same country, which satisfies the requirements for a like-kind exchange.

Question 19

Johnson Builders is in the new residential construction business. They built a house that sat empty for 6 months after its completion. This type of property would be categorized as a:

Accepted Answer

Dealer property is the correct category because Johnson Builders is in the business of building and selling homes. The house sitting empty after completion indicates it is inventory for sale, characteristic of dealer property.

Question 20

When an investment appreciates in value during the investment holding period, the appreciation is generally taxed at which of the following rates?

Accepted Answer

Appreciation on an investment is treated as a capital gain, and therefore, is taxed at capital gain tax rates. The rate is determined by how long the investment was held, with long-term capital gains being taxed at a lower rate than short-term capital gains.

Quiz 20: Income Taxation and Value