Real Estate Investing Tax Implications of Ownership 3 — Questions and Answers
Question 1: What is the Net Investment Income Tax (NIIT) rate that applies to passive rental income for high-income investors?
- 2.9%
- 3.8% (Correct answer)
- 5.0%
- 6.2%
Correct answer: 3.8%
The Net Investment Income Tax imposes an additional 3.8% tax on passive investment income, including rental income, for taxpayers above certain income thresholds.
Question 2: Under the passive activity loss rules, when can a real estate professional deduct rental losses against ordinary income without limitation?
- Never — rental losses are always limited
- When they materially participate and meet real estate professional status requirements (Correct answer)
- Only when the losses exceed $25,000
- When they own more than 10 rental properties
Correct answer: When they materially participate and meet real estate professional status requirements
Taxpayers qualifying as real estate professionals — spending more than 750 hours and more than half their working time in real estate activities — can deduct rental losses against ordinary income.
Question 3: What tax benefit allows investors to defer capital gains by reinvesting proceeds from a sold property into a like-kind property?
- Section 121 exclusion
- Section 1031 exchange (Correct answer)
- Section 179 deduction
- Opportunity Zone investment
Correct answer: Section 1031 exchange
A Section 1031 like-kind exchange allows investors to defer capital gains taxes by reinvesting proceeds from a sold investment property into another qualifying like-kind property.
Question 4: How long does a commercial building (nonresidential real property) take to fully depreciate under MACRS?
- 27.5 years
- 31.5 years
- 39 years (Correct answer)
- 40 years
Correct answer: 39 years
Under MACRS, nonresidential real property (commercial buildings) is depreciated over 39 years using the straight-line method.
Question 5: Which of the following correctly describes a 'step-up in basis' at death for inherited real estate?
- The heir inherits the decedent's original purchase price as their basis
- The heir's basis is stepped up to the property's fair market value at the date of death (Correct answer)
- The heir must pay capital gains tax on appreciation before the date of death
- The basis is calculated using the property's assessed value for estate taxes
Correct answer: The heir's basis is stepped up to the property's fair market value at the date of death
When real property is inherited, the heir receives a stepped-up basis equal to the fair market value at the date of death, eliminating capital gains tax on pre-death appreciation.
Question 6: What is 'boot' in the context of a 1031 exchange?
- The identification period for replacement properties
- Cash or non-like-kind property received in an exchange, which is taxable (Correct answer)
- The minimum equity required in the replacement property
- A penalty for failing to complete a deferred exchange
Correct answer: Cash or non-like-kind property received in an exchange, which is taxable
Boot is any cash or non-like-kind property received in a 1031 exchange, and it is taxable to the recipient in the year of the exchange.
Question 7: Which tax form is used to report the sale or exchange of business or investment real estate?
- Form 1099-S
- Form 4797 (Correct answer)
- Schedule D only
- Form 8949 only
Correct answer: Form 4797
Form 4797 (Sales of Business Property) is used to report gains and losses from the sale of business or investment real estate, including depreciation recapture.
Real Estate Investing Tax Implications of Ownership 3
What is the Net Investment Income Tax (NIIT) rate that applies to passive rental income for high-income investors?