Real Estate Investing Real Estate Taxation Questions and Answers β Questions and Answers
Question 1: An investor purchases a residential rental property for $450,000. The land is valued at $100,000. Under the Modified Accelerated Cost Recovery System (MACRS), what is the annual depreciation deduction the investor can claim?
- $8,974.36
- $12,727.27 (Correct answer)
- $11,538.46
- $16,363.64
Correct answer: $12,727.27
The IRS mandates that residential rental property be depreciated over 27.5 years. Land value is not depreciable and must be subtracted from the purchase price to find the depreciable basis. The calculation is: ($450,000 Purchase Price - $100,000 Land Value) / 27.5 Years = $12,727.27.
Question 2: An investor sells a rental property held for 8 years. The total gain is $200,000, which consists of $120,000 from market appreciation and $80,000 from accumulated depreciation. How are these two components of the gain taxed at the federal level?
- The entire $200,000 is taxed at the long-term capital gains rate.
- The $120,000 appreciation is taxed at ordinary income rates, and the $80,000 depreciation is taxed at the long-term capital gains rate.
- The $120,000 appreciation is taxed at the long-term capital gains rate, and the $80,000 is subject to depreciation recapture tax, capped at 25%. (Correct answer)
- The entire $200,000 is taxed as ordinary income.
Correct answer: The $120,000 appreciation is taxed at the long-term capital gains rate, and the $80,000 is subject to depreciation recapture tax, capped at 25%.
The portion of the gain from market appreciation ($120,000) is taxed at the more favorable long-term capital gains rates (0%, 15%, or 20% depending on income). The portion of the gain attributable to claimed depreciation ($80,000) is subject to depreciation recapture, which is taxed at a maximum rate of 25%.
Question 3: To successfully execute a 1031 like-kind exchange and defer capital gains taxes, an investor must adhere to strict IRS timelines after closing on the sale of the relinquished property. Which of the following timelines is correct?
- Identify replacement properties within 30 days and close within 120 days.
- Identify replacement properties within 60 days and close within 240 days.
- Identify replacement properties within 90 days and close within 180 days.
- Identify replacement properties within 45 days and close within 180 days. (Correct answer)
Correct answer: Identify replacement properties within 45 days and close within 180 days.
The IRS rules for a 1031 exchange are very strict. An investor has 45 calendar days from the date of closing on the relinquished property to formally identify potential replacement properties. They then have a total of 180 calendar days from the initial closing date to acquire the replacement property.
Question 4: Which of the following costs associated with a residential rental property is generally NOT a currently deductible expense but must be capitalized and depreciated over time?
- Replacing a broken window.
- Paying the annual property insurance premium.
- Installing a new central air conditioning system. (Correct answer)
- Hiring a plumber to fix a leaking faucet.
Correct answer: Installing a new central air conditioning system.
Installing a new central air conditioning system is considered a capital improvement because it adds significant value and extends the property's useful life. Such costs must be capitalized and depreciated over 27.5 years for a residential property. In contrast, repairs like fixing a window or leak, and operating expenses like insurance, are currently deductible in the year they are paid.
Question 5: An investor actively participates in their rental property management but is not a real estate professional. Under the special allowance for passive activity losses, what is the maximum amount of rental loss they can typically deduct against non-passive income, assuming their Modified Adjusted Gross Income (MAGI) is below $100,000?
- $3,000
- $25,000 (Correct answer)
- $10,000
- $50,000
Correct answer: $25,000
The IRS allows a special allowance for taxpayers who actively participate in a passive rental activity. If their MAGI is below $100,000, they can deduct up to $25,000 in passive losses against their non-passive income (like a salary). This allowance phases out for incomes between $100,000 and $150,000.
Question 6: An investor purchases a property for $300,000. They pay $8,000 in closing costs (e.g., title fees, legal fees) and immediately invest $42,000 to completely renovate the kitchen. What is the investor's initial adjusted cost basis in the property?
- $300,000
- $308,000
- $342,000
- $350,000 (Correct answer)
Correct answer: $350,000
The initial adjusted cost basis is calculated by taking the original purchase price, adding certain closing costs, and adding the cost of capital improvements. Therefore, the basis is $300,000 (purchase price) + $8,000 (closing costs) + $42,000 (capital improvement) = $350,000.
Real Estate Investing Real Estate Taxation Questions and Answers
An investor purchases a residential rental property for $450,000.
The land is valued at $100,000.
Under the Modified Accelerated Cost Recovery System (MACRS), what is the annual depreciation deduction the investor can claim?