Chapter 18 Concepts

Question 1

Tax-Deductible Loan Expenses

Answer 1

-Loan discount points. Those that are prepaid interest to reduce the loan interest rate when acquiring a residence, not a refinance, are deductible in the year of purchase.

-Mortgage prepayment penalties. Rare in North Carolina.

-Mortgage insurance premiums. If certain income requirements are met.

-Some loan origination fees. If they are quoted as a percent of the loan amount and if paid to obtain the loan. (Brokers and buyers should check with their tax advisers before assuming that such fees may or may not be deductible.)

-Mortgage interest payments on a principal residence and second homes. As of 2018, for a principal residence, a second residence, or both, the total amount of acquisition debt for which interest can be deducted cannot exceed a total of $750,000.

Question 2

Real Property Taxes

1) when are they deductible?

2) deductions for real property taxes can be taken on

Answer 2

are deductible in the year paid

Deductions for real property taxes can be taken on a principal residence as well as on a second home; however, effective in 2018, the total of state and local taxes will be limited to a $10,000 deduction per year.

Question 3

Mortgage interest, property taxes, and repairs are tax-deductible items for homeowners. (t/f)

Answer 3

false

Mortgage interest and property taxes are tax-deductible, but homeowners cannot take a deduction for repairs.

Question 4

There are no limits on the amount of mortgage interest and property tax deductions for homeowners. (t/f)

Answer 4

false

There are limits on the amount of mortgage interest and property tax deductions for homeowners. Homeowners cannot write off the interest on more than a $750,000 loan amount and no more than $10,000 of property tax (and other state and local taxes)

Question 5

What is Capital gain?

Answer 5

the profits realized from the sale or exchange of property

If a person sells a painting for $10,000 that was acquired for $6,000, that person has recognized a gain, that is, income, of $4,000, and that income is taxable (unless specifically excluded by the tax code). So it is with the buying and selling of real property.

Question 6

short-term capital gain

Answer 6

profits from assets owned for 12 months or less

Question 7

long-term capital gain

Answer 7

A gain on a capital asset that has been held for more than one year, resulting in a more favorable capital gains tax rate is currently 20% (not the ordinary 39.6%)

Question 8

Cost Basis

Answer 8

is the owner’s initial cost for the real estate (purchase price plus allowable closing expenses)

Question 9

Adjusted Basis

Answer 9

The owner of a property can add to the cost basis, the cost of any physical capital improvements that add value to the property or prolong its life

Question 10

Amount Realized

Answer 10

(sales price minus allowable closing expenses) exceeds the property’s adjusted basis is the capital gain subject to taxation.

Question 11

capital loss

Answer 11

If the amount realized is less than the adjusted basis, a capital loss has occurred

Question 12

Purchase price + Allowable closing costs + Capital improvements =

Answer 12

Adjusted Basis

Question 13

Tax-Free Gains from Sale of Principal Residence

Answer 13

-capital gains—up to $500,000 for a married couple filing jointly and up to $250,000 for a single person or a married person filing singly—from the sale of a principal residence are excluded from taxation.

If a seller has gains that exceed the $500,000 or $250,000 limit, those gains will be currently taxed at the maximum 20% long-term capital gains rate.

Question 14

Tax-Free Gains From Sale of Principal Residence restrictions on this tax benefit (2)

Answer 14

(1) the seller must have occupied the property as a primary residence for two of the previous five years (residency does not have to be continuous)

(2) the exclusion is available only once every two years. Because of the first restriction, this exclusion of gain does not apply to vacation properties or second homes

Question 15

Residential homeowners who have sold their primary residence at a loss cannot write off the loss on their income tax the year following the sale. (t/f)

Answer 15

true

Residential property owners are eligible for capital gains tax benefits but cannot write off the loss on the sale of their residences

Question 16

installment sale

Answer 16

When a seller finances the sale of the seller’s property (as with the use of a contract for deed or purchase money mortgage), or when the seller is to receive all or some portion of the sales price in a year or years other than the year of sale. With an installment sale, the taxpayer is taxed on a pro rata portion of the total gain as each installment actually is received.

For example, if a taxpayer received a gain of $10,000 on a $100,000 contract price, her profit percentage would be 10%. If during the tax year she received $5,000 in principal payments, 10% of those payments would be taxable that year. Ten percent of $5,000 is $500. She would have to report a taxable gain of $500 in that tax year.

Question 17

Vacation Homes

Answer 17

But if the owner personally uses the property for more than 14 days per year, or for more than 10% of the number of days for which the property is rented, whichever is greater, certain deductions will be disallowed

Question 18

Tax Deferred Exchange

Answer 18

offers significant tax advantages because no matter how much a property has appreciated since its initial purchase, it may be exchanged for another property and the taxpayer may be able to defer taxes on the entire gain

Question 19

The requirements for a tax-deferred exchange (Section 1031 Exchange)

Answer 19

there must be a property transferred (relinquished property) and a property received (replacement property). These properties must be exchanged—they cannot be sold. Both the property transferred and the property received must be held for productive use in a trade or business or for investment

Finally, the properties must be like-kind properties. Essentially, the like-kind requirement is met when real estate is exchanged for real estate. An apartment building can be exchanged for an office building or gas station, and the exchange will still qualify as like-kind. The apartment building real estate does not have to be exchanged for an apartment building to qualify

Question 20

boot

Answer 20

Sometimes, a property is exchanged for another property that is worth substantially more or less money. When this happens, cash or personal property may be included in the transaction to even out the value of the exchange. The party receiving boot is taxed on the value of the boot at the time of the exchange.

Question 21

Depreciation (tax)

Answer 21

allows an investor to recover the cost of an income-producing asset by taking tax deductions over the period of the asset’s useful life

Question 22

Cost recovery deductions may be taken only on

Answer 22

personal property and improvements to land and only if they are used in a trade or business or for the production of income. Cost recovery deductions cannot be claimed on a principal residence or on land (technically, land never wears out or becomes obsolete).

Question 23

The amount of loss that may be deducted depends on the following factors per the Tax Reform Act of 1986:

Answer 23

-Whether an investor actively participates in the day-to-day management of the rental property or makes management decisions

-The amount of the loss

-The source of the income against which the loss is to be deducted

Question 24

Investors who do not actively participate in the management or operation of the real estate are considered

Answer 24

passive investors, which prevents them from using a loss to offset active income.