Real Estate Investing Real Estate Taxation 3 β Questions and Answers
Question 1: A real estate investor qualifies as a 'real estate professional' for tax purposes. What does this allow them to do?
- Avoid all property taxes
- Deduct rental losses without limitation against ordinary income (Correct answer)
- Use a 15-year depreciation schedule
- Exclude 100% of capital gains
Correct answer: Deduct rental losses without limitation against ordinary income
Real estate professionals (750+ hours/year in real property trades) can treat rental activities as non-passive, allowing unlimited deduction of rental losses against ordinary income.
Question 2: What is the 'stepped-up basis' benefit that heirs receive on inherited real estate?
- The basis is reduced to zero
- The basis resets to fair market value at the date of death (Correct answer)
- The basis carries over from the deceased owner
- The basis is the original purchase price plus inflation
Correct answer: The basis resets to fair market value at the date of death
Inherited real estate receives a stepped-up basis equal to the fair market value at the decedent's date of death, eliminating any built-up capital gain tax liability.
Question 3: How does the IRS distinguish between a deductible repair and a capital improvement on rental property?
- Anything over $500 is a capital improvement
- Repairs restore property to original condition; improvements add value or extend useful life (Correct answer)
- All labor costs are repairs; all material costs are improvements
- Only licensed contractor work qualifies as a capital improvement
Correct answer: Repairs restore property to original condition; improvements add value or extend useful life
Repairs maintain property in its current condition and are immediately deductible, while capital improvements add value, extend useful life, or adapt the property to a new use and must be capitalized.
Question 4: What is the tax treatment of mortgage interest paid on a rental property?
- It is not deductible on rental property
- It is deductible as a rental expense on Schedule E (Correct answer)
- It qualifies for the mortgage interest deduction on Schedule A only
- It is deductible only up to $750,000 of loan value
Correct answer: It is deductible as a rental expense on Schedule E
Mortgage interest on rental property is fully deductible as an ordinary rental expense on Schedule E, not subject to the personal mortgage interest deduction limits of Schedule A.
Question 5: An investor uses a Delaware Statutory Trust (DST) to complete a 1031 exchange. What is the primary tax advantage?
- DST income is exempt from federal taxes
- DST interests qualify as like-kind replacement property in a 1031 exchange (Correct answer)
- DST investments receive accelerated depreciation
- DST investors pay no depreciation recapture
Correct answer: DST interests qualify as like-kind replacement property in a 1031 exchange
DST beneficial interests qualify as like-kind replacement property in a 1031 exchange, allowing investors to defer capital gains while gaining access to institutional-quality properties.
Question 6: What is the 'net investment income tax' (NIIT) rate that may apply to real estate gains for high-income investors?
- 2.9%
- 3.8% (Correct answer)
- 5.0%
- 7.5%
Correct answer: 3.8%
The NIIT imposes a 3.8% surtax on the lesser of net investment income or the amount by which modified AGI exceeds $200,000 (single) or $250,000 (married filing jointly).
Question 7: Which IRS form is used to report rental income and expenses for residential rental property?
- Form 4797
- Schedule D
- Schedule E (Correct answer)
- Form 8949
Correct answer: Schedule E
Rental income and expenses from residential rental property are reported on Schedule E (Supplemental Income and Loss), which is attached to Form 1040.
Real Estate Investing Real Estate Taxation 3
A real estate investor qualifies as a 'real estate professional' for tax purposes.
What does this allow them to do?