Real Estate Investing Real Estate Taxation 4 — Questions and Answers
Question 1: What is 'bonus depreciation' and how does it benefit real estate investors?
- An extra 10% deduction on top of regular depreciation
- 100% first-year expensing of eligible short-lived property identified in a cost segregation study (Correct answer)
- A special deduction for properties in Opportunity Zones
- An accelerated depreciation method for properties over $1 million
Correct answer: 100% first-year expensing of eligible short-lived property identified in a cost segregation study
Bonus depreciation allows investors to immediately deduct 100% (phasing down after 2022) of the cost of eligible property (5, 7, 15-year class assets) in the year placed in service.
Question 2: A property investor sells a commercial building for $2 million with an adjusted basis of $800,000. Straight-line depreciation claimed was $400,000. What is the unrecaptured Section 1250 gain?
- $0
- $200,000
- $400,000 (Correct answer)
- $1,200,000
Correct answer: $400,000
Unrecaptured Section 1250 gain equals the total straight-line depreciation previously claimed ($400,000), which is taxed at a maximum 25% rate rather than lower capital gains rates.
Question 3: Under Section 179, what limitation applies to rental real estate?
- Section 179 applies fully to all rental property
- Section 179 cannot be used for property used predominantly to furnish lodging (Correct answer)
- Section 179 is limited to $25,000 for rental properties
- Section 179 requires 5-year holding before claiming
Correct answer: Section 179 cannot be used for property used predominantly to furnish lodging
Section 179 expensing generally cannot be used for property used to furnish lodging (such as residential rental property), making bonus depreciation the preferred acceleration strategy.
Question 4: What is a 'triple net lease' (NNN) and what are its tax implications for the landlord?
- The tenant pays all operating expenses; the landlord's deductible expenses are reduced accordingly (Correct answer)
- The landlord pays triple the normal property taxes
- Net income is taxed at one-third the normal rate
- Three parties share the lease obligation
Correct answer: The tenant pays all operating expenses; the landlord's deductible expenses are reduced accordingly
In a NNN lease, the tenant pays property taxes, insurance, and maintenance; while this reduces landlord expenses, it also reduces their deductible operating costs, leaving primarily depreciation and mortgage interest as deductions.
Question 5: How are self-employment taxes treated for real estate rental income?
- All rental income is subject to self-employment tax
- Rental income is generally exempt from self-employment tax unless the investor is a real estate dealer (Correct answer)
- Real estate professionals pay double self-employment tax
- Rental income over $100,000 is subject to self-employment tax
Correct answer: Rental income is generally exempt from self-employment tax unless the investor is a real estate dealer
Passive rental income is generally not subject to the 15.3% self-employment tax; however, real estate dealers who sell property as ordinary income may owe SE tax on those profits.
Question 6: What is an 'installment sale' and its primary tax benefit for real estate sellers?
- A sale where payments are made monthly without tax benefit
- A method that spreads capital gain recognition over multiple years as payments are received (Correct answer)
- A sale that eliminates all capital gains taxes
- A sale that converts capital gains to ordinary income
Correct answer: A method that spreads capital gain recognition over multiple years as payments are received
An installment sale (IRC Section 453) allows the seller to recognize gain proportionally as principal payments are received, potentially keeping the seller in lower tax brackets across multiple years.
Question 7: What is the primary tax advantage of holding real estate in a self-directed IRA?
- Property taxes are eliminated
- Rental income and gains grow tax-deferred (traditional) or tax-free (Roth) (Correct answer)
- Depreciation deductions double
- No capital gains tax ever applies
Correct answer: Rental income and gains grow tax-deferred (traditional) or tax-free (Roth)
Real estate held in a self-directed IRA allows rental income and appreciation to compound tax-deferred in a traditional IRA or tax-free in a Roth IRA, though UBIT rules may apply to debt-financed property.
Real Estate Investing Real Estate Taxation 4
What is 'bonus depreciation' and how does it benefit real estate investors?