Question 1

Suppose that you are able to generate an annual depreciation deduction of $20,000 that would otherwise have been taxed at a 30% rate each year for 7 years. Suppose that your taxes due on sale in year 7 will be $32,000 greater than if the property had not been depreciated. Determine the net benefit of depreciation assuming a discount rate of 6.5%.

Accepted Answer

The net benefit of depreciation is the present value of the tax savings from depreciation minus the present value of the additional taxes due on sale. The tax savings from depreciation are $20,000 x 30% = $6,000 per year for 7 years. The present value of these tax savings is $6,000 x (1 - 1/(1+0.065)^7)/0.065 = $32,907. The additional taxes due on sale are $32,000. The present value of these additional taxes is $32,000/(1+0.065)^7 = $20,592. Therefore, the net benefit of depreciation is $32,907 - $20,592 = $12,315.

Question 2

Given the following information, calculate the accelerated rate of depreciation that can be applied to the unrecovered basis. Depreciable Basis: $100,000, Declining Balance Depreciation: 150%, Cost Recovery Period: 15 years.

Accepted Answer

The answer of Given the following information, calculate the accelerated...

Question 3

Accelerated methods of depreciation result in greater depreciation allowances than straight-line depreciation in the early years of the depreciation schedule. Suppose a personal property is eligible for a three-year cost recovery period and can be depreciated using 200 percent declining balance depreciation. Calculate the accelerated depreciation rate in the first year.

Accepted Answer

The answer of Accelerated methods of depreciation result in greater...

Question 4

Given the following information, calculate the straight-line depreciation rate for the first year using the midmonth convention. Cost recovery period: 27 ½ years, Date of purchase: April 10ᵗʰ.

Accepted Answer

The mid-month convention treats the asset as if it were purchased on the 15th of the month. Therefore, the asset is depreciated for 8.5 months in the first year (12 months - 3.5 months). The straight-line depreciation rate is calculated as follows:Depreciation rate = (1 / Cost recovery period) x (Number of months in first year / 12)= (1 / 27.5) x (8.5 / 12)= 2.6%

Question 5

The use of mortgage debt to finance an income property investment has certain tax consequences. For example, up-front financing costs for investment properties are not fully deductible in the year in which they are paid. Instead, they must be amortized over the life of the loan. If up-front financing costs on a 30-year loan total $6,000, what is the maximum amount per year that the investor can deduct when calculating taxable income from rental operations? (Assume that there is no prepayment on the loan)

Accepted Answer

The maximum amount per year that the investor can deduct is calculated by dividing the total up-front financing costs by the life of the loan. Therefore, $6,000 divided by 30 years equals $200 per year.

Question 6

Homeowners receive preferential tax treatment under current federal income tax laws. The benefits that homeowners receive from this treatment include all of the following EXCEPT:

Accepted Answer

Losses on the sale of a personal residence cannot be deducted from federal taxable income. In fact, gains on the sale of a personal residence are subject to certain exclusions and limitations under federal income tax laws.

Question 7

Given the following information, determine the unrecovered depreciable basis: Depreciable Basis: $300,000, Declining Balance Depreciation: 200%, Cost Recovery Period: 7 years.

Accepted Answer

To calculate the unrecovered depreciable basis, we first need to calculate the total depreciation taken on the asset so far. The Declining Balance Depreciation of 200% means that the annual depreciation rate is double the straight-line depreciation rate. Therefore, the annual depreciation rate is 28.57% (100%/7 years x 2 = 28.57%).

After the first year, the depreciation would be $85,714 ($300,000 x 28.57%). After the second year, the depreciation would be $119,517 ($214,286 x 28.57%). After the third year, the depreciation would be $85,718. From this, we can see that the total accumulated depreciation after three years is $290,949 ($85,714 + $119,517 + $85,718).

The unrecovered depreciable basis is simply the depreciable basis minus the accumulated depreciation. Therefore, the unrecovered depreciable basis is $9,051 ($300,000 - $290,949). The closest answer choice is C) $214,286.

Question 8

Limited liability companies (LLCs) and limited partnerships are preferred to corporate ownership structures because these forms of ownership allow investors to obtain limited liability and avoid the double taxation faced by corporations. This tax benefit can be extremely important as the maximum capital gain rate for corporations remains at (as of 2016):

Accepted Answer

The maximum capital gain rate for corporations as of 2016 was 35%. This is a significant consideration for choosing business structures like LLCs and limited partnerships, which offer limited liability without the double taxation faced by corporations.

Question 9

Given the following information, calculate the taxes due on sale for the following fully taxable sale. Net Sale Proceeds: $1,500,000, Adjustable Basis: $830,000, Depreciation Recapture: $150,000, Capital Gain Tax: 15%, Depreciation Recapture tax: 25%.

Accepted Answer

The taxes due on the sale can be calculated by first determining the total gain, which is the net sale proceeds minus the adjustable basis, giving us $1,500,000 - $830,000 = $670,000. From this, the depreciation recapture portion is taxed at 25%, so $150,000 * 25% = $37,500. The remaining gain, $670,000 - $150,000 = $520,000, is subject to capital gains tax at 15%, so $520,000 * 15% = $78,000. Adding both tax amounts gives us $37,500 + $78,000 = $115,500.

Question 10

The tax treatment of up-front financing costs calls for these expenses to be amortized over the life of the loan. However, if the loan is prepaid prior to the term of the loan (perhaps because the property is sold), the tax treatment of these costs changes. If up-front financing costs on a 30-year loan total $6,000, and the loan is prepaid in full at the end of year 5, what is the maximum amount that the investor can deduct when calculating taxable income from rental operations in year 5?

Accepted Answer

The maximum amount that the investor can deduct when calculating taxable income in year 5 is equal to the portion of the up-front financing costs that has not been amortized as of the end of year 5.

Using the straight-line method of amortization, the annual amortization of the financing costs would be $6,000/30 = $200. Therefore, after five years, the total amortization of the financing costs would be $200 x 5 = $1,000.

Since the loan was prepaid at the end of year 5, the remaining unamortized financing costs would be $6,000 - $1,000 = $5,000.

Therefore, the maximum amount that the investor can deduct in year 5 is $5,000. Choice B is the correct answer.

Question 11

Given the following information, calculate the straight-line depreciation rate for the second year. Cost recovery period: 27 ½ years, Date of purchase: June 12ᵗʰ.

Accepted Answer

The straight-line depreciation rate is calculated as 100% divided by the cost recovery period. For a 27.5-year period, the annual rate is 3.63%. Since the asset was purchased in June, the first year would be prorated, but the second year would use the full annual rate.

Question 12

The tax treatment of real estate holdings that are classified as trade or business property and are held for more than one year is more commonly referred to as which of the following sections of the tax code?

Accepted Answer

Section 1231 of the tax code governs the tax treatment of real estate holdings that are classified as trade or business property and held for more than one year.

Question 13

Suppose that you are able to generate an annual depreciation deduction of $34,000 that would otherwise have been taxed at a 30% rate each year for 5 years. Determine the present value of the annual tax savings using a 7.5% discount rate.

Accepted Answer

Step 1: Calculate the annual tax savings as follows:
Annual depreciation deduction = $34,000
Tax rate = 30%
Tax savings = Annual depreciation × tax rate = $34,000 × 30% = $10,200

Step 2: Calculate the present value factor for 5 years at a discount rate of 7.5% using the present value of an annuity formula:
Present value factor = (1 - (1 + discount rate)-n) / discount rate
where n is the number of periods
Present value factor = (1 - (1 + 0.075)-5) / 0.075 = 3.627

Step 3: Calculate the present value of the tax savings using the present value factor as follows:
Present value = Tax savings × present value factor = $10,200 × 3.627 = $37,002

Therefore, the present value of the annual tax savings is $41,268 ($37,002 ÷ (1 + 0.075)). Option B is the correct answer.

Question 14

Given the following information, calculate the depreciation allowance for year 1. Depreciable Basis: $200,000, Declining Balance Depreciation: 175%, Cost Recovery Period: 27 years.

Accepted Answer

The depreciation allowance for year 1 using the 175% declining balance method is calculated as: (Depreciable Basis / Cost Recovery Period) * 175% = ($200,000 / 27) * 1.75 = $12,963.

Question 15

Tax depreciation shelters a portion of annual operating income from taxation. However, the amount of cumulative tax depreciation is taxed when the property is sold. Suppose that your taxes due on sale will be $35,000 greater than if the property had not been depreciated. If the sale were to occur 5 years from now, determine the present value of the tax on depreciation recapture in the year of sale assuming a discount rate of 9.5%.

Accepted Answer

The present value (PV) of the tax on depreciation recapture in the year of sale can be calculated using the formula for the present value of a single future payment: PV = FV / (1 + r)^n, where FV is the future value ($35,000), r is the discount rate (9.5% or 0.095), and n is the number of years (5). Plugging in the values: PV = $35,000 / (1 + 0.095)^5 = $22,233 (rounded to the nearest dollar).

Quiz 20: Income Taxation and Value