Real Estate Investing Real Estate Taxation 5 — Questions and Answers
Question 1: What is 'Unrelated Business Income Tax' (UBIT) as it applies to real estate in an IRA?
- A tax on rental income exceeding $10,000 per year
- A tax on income from debt-financed property held in a tax-exempt account like an IRA (Correct answer)
- A penalty for early withdrawal of real estate profits from an IRA
- A city tax on commercial rental income
Correct answer: A tax on income from debt-financed property held in a tax-exempt account like an IRA
UBIT applies to income generated by debt-financed property (mortgaged real estate) held in an IRA or other tax-exempt entity, taxing the leveraged portion of income at trust tax rates.
Question 2: A landlord spends $15,000 replacing all windows in a rental property. Under current IRS rules (Tangible Property Regulations), this expenditure is most likely treated as:
- An immediately deductible repair
- A capital improvement that must be depreciated (Correct answer)
- A Section 179 deduction
- A deduction only if the tenant reimburses the cost
Correct answer: A capital improvement that must be depreciated
Under the IRS Tangible Property Regulations, replacing all windows in a building unit of property constitutes a betterment or restoration, requiring capitalization and depreciation over the applicable recovery period.
Question 3: What is the 'safe harbor' rule for small taxpayers under the IRS Tangible Property Regulations?
- Properties under $250,000 in value may expense all repairs immediately
- Taxpayers may elect to expense repairs/improvements up to the lesser of $10,000 or 2% of the unadjusted basis of the building per year (Correct answer)
- Any single expenditure under $2,500 may be immediately expensed
- Only licensed contractors may claim the safe harbor deduction
Correct answer: Taxpayers may elect to expense repairs/improvements up to the lesser of $10,000 or 2% of the unadjusted basis of the building per year
The small taxpayer safe harbor allows landlords with gross receipts under $10 million to expense amounts up to the lesser of $10,000 or 2% of the building's unadjusted basis per year without capitalizing.
Question 4: How is property inherited through a trust typically treated for tax basis purposes compared to property directly inherited from a decedent?
- Trust-inherited property always gets a stepped-down basis
- The tax treatment depends on the trust type — revocable trusts get a step-up; irrevocable trusts may not (Correct answer)
- All inherited property has the same basis rules regardless of trust type
- Trust-inherited property retains the grantor's original cost basis always
Correct answer: The tax treatment depends on the trust type — revocable trusts get a step-up; irrevocable trusts may not
Property in a revocable living trust is included in the decedent's estate and receives a stepped-up basis, while assets in irrevocable trusts may not qualify for the step-up since they were removed from the estate.
Question 5: What is 'like-kind' property in the context of a 1031 exchange for real estate?
- The replacement property must be in the same city as the relinquished property
- Any real property held for investment or business use qualifies as like-kind to other real property (Correct answer)
- The properties must be the same type (e.g., apartment for apartment)
- The replacement property must have the same or lower value
Correct answer: Any real property held for investment or business use qualifies as like-kind to other real property
For real estate, 'like-kind' is broadly interpreted — any U.S. real property held for investment or business use qualifies as like-kind to any other U.S. real property held for investment or business.
Question 6: Which of the following correctly describes the tax treatment of a real estate partnership's losses passed through to a limited partner?
- Limited partners can always deduct their share of losses against any income
- Partnership losses passed to limited partners are generally passive and can only offset passive income (Correct answer)
- Limited partners receive a 50% deduction on all partnership losses
- Partnership losses are suspended until the partner sells their interest
Correct answer: Partnership losses passed to limited partners are generally passive and can only offset passive income
Limited partners are generally considered passive investors, so their share of partnership losses is classified as passive and can only be used to offset passive income, not wages or portfolio income.
Question 7: What is the tax consequence of converting a primary residence to a rental property and then selling it?
- The Section 121 exclusion applies in full regardless of rental period
- The Section 121 exclusion is pro-rated based on qualified vs. non-qualified use periods (Correct answer)
- Converting to rental permanently eliminates the Section 121 exclusion
- No capital gains tax applies because it was originally a primary residence
Correct answer: The Section 121 exclusion is pro-rated based on qualified vs. non-qualified use periods
After 2008, periods of non-qualified use (including rental use) reduce the Section 121 exclusion proportionally, so only the fraction of gain attributable to qualified use periods is excluded.
Real Estate Investing Real Estate Taxation 5
What is 'Unrelated Business Income Tax' (UBIT) as it applies to real estate in an IRA?