Real Estate Investing Tax Implications of Ownership Questions and Answers

Question 1

According to the Modified Accelerated Cost Recovery System (MACRS), what is the standard depreciation period for a residential rental property in the United States?

Accepted Answer

27.5 years

Answer

The IRS specifies that the cost of residential rental property is recovered over a period of 27.5 years using the straight-line method. The 39-year period applies to nonresidential (commercial) real property.

Question 2

An investor owns a rental property and incurs several expenses. Which of the following expenditures must be capitalized and depreciated, rather than being fully deducted as a current operating expense?

Accepted Answer

Installing a new roof on the entire building.

Answer

Installing a new roof is a capital improvement because it extends the property's useful life and adds significant value. It must be capitalized and depreciated over time. The other options are routine maintenance or repairs, which are considered immediately deductible operating expenses.

Question 3

An investor sells an apartment building and wants to defer capital gains taxes by executing a 1031 exchange. Which of the following actions would DISQUALIFY the transaction from tax-deferred status?

Accepted Answer

Taking possession of the sale proceeds for one week before wiring them to a qualified intermediary.

Answer

A fundamental rule of a 1031 exchange is that the investor cannot have actual or constructive receipt of the sale proceeds. The funds must be handled by a qualified intermediary from the moment of sale. Taking possession of the cash, even briefly, invalidates the exchange and makes the capital gains immediately taxable.

Question 4

An investor has a modified adjusted gross income (MAGI) of $90,000 and actively participates in managing a rental property that produced a tax loss of $18,000 this year. According to the special allowance for rental real estate activities, how much of this loss can the investor deduct against their non-passive income?

Accepted Answer

$18,000, the full amount of the loss.

Answer

The IRS allows taxpayers who actively participate in rental real estate to deduct up to $25,000 of passive losses against non-passive income, provided their MAGI is $100,000 or less. Since the investor's MAGI is below the threshold and their loss of $18,000 is less than the $25,000 cap, they can deduct the entire loss.

Question 5

An investor purchases a property for $400,000. They incur $6,000 in closing costs (e.g., legal fees, recording fees) and immediately spend $40,000 on a new HVAC system. What is the investor's adjusted cost basis in the property immediately after this work?

Accepted Answer

$446,000

Answer

The initial cost basis is the purchase price plus certain allowable closing costs. Capital improvements, like a new HVAC system, are then added to this basis. Therefore, the adjusted basis is $400,000 (purchase price) + $6,000 (closing costs) + $40,000 (HVAC system) = $446,000.

Real Estate Investing Practice Test

Real Estate Investing Practice Test

Real Estate Investing Tax Implications of Ownership Questions and Answers