Real Estate Investing Tax Implications of Ownership 5

Question 1

What is 'phantom income' in real estate investing?

Accepted Answer

Taxable income that arises without a corresponding cash payment to the investor

Answer

Phantom income occurs when a taxable event (such as debt forgiveness or a partner's share of income) creates a tax liability without the investor actually receiving cash.

Question 2

How does the IRS treat cancellation of debt (COD) income when a lender forgives part of a mortgage on an investment property?

Accepted Answer

It is generally taxable as ordinary income unless an exclusion applies

Answer

Cancellation of debt income is generally taxable as ordinary income, though exclusions may apply if the taxpayer is insolvent or the property is in bankruptcy.

Question 3

An investor owns a rental property in an LLC taxed as a partnership. How does rental income flow to the investor for tax purposes?

Accepted Answer

Income passes through to the investor's personal return and is taxed at individual rates

Answer

In a partnership-taxed LLC, income and losses pass through directly to the members' personal tax returns, reported via Schedule K-1, and taxed at individual rates.

Question 4

Which depreciation method is required for residential rental property under MACRS?

Accepted Answer

Straight-line over 27.5 years

Answer

Residential rental property must be depreciated using the straight-line method over 27.5 years under the Modified Accelerated Cost Recovery System (MACRS).

Question 5

What happens to unused passive activity losses from a rental property when the property is sold in a fully taxable transaction?

Accepted Answer

They are released and can offset any type of income in the year of sale

Answer

When a passive activity property is disposed of in a fully taxable transaction, all suspended (unused) passive activity losses are released and can offset any type of income in the year of sale.

Real Estate Investing Practice Test

Real Estate Investing Practice Test

Real Estate Investing Tax Implications of Ownership 5