CH 23-1: Income Tax & Property Ownership (23)

TRUE or FALSE: Freddie owns a lake house in addition to his principal residence. He rented the lake house for the months of January and February. Since Freddie rented the lake house for more than 14 days this year, he will NOT be able to deduct the property taxes he paid on it.

False - Certain items can be deducted from a property owner’s income tax regardless of whether the property is a principal residence or a different personal use property—even one the owner rents out. These items include property taxes, mortgage interest and other loan costs, and certain casualty or theft losses. Because he rents out the lake house for more than 14 days, however, Freddie may be able to take additional deductions, but he would also have to claim the income earned.

Rita just bought a four-unit apartment building. The property cost her $375,000. If the land is valued at $75,000, how much can Rita deduct from her annual income taxes?

$7,692

$9,615

$10,345

$10909

$10,909

YES or NO: Vee bought her dream home when the market was hot and paid more than market value to beat out the other buyers. After five years of living in the house, interest rates have gone up, and property values have gone down. Vee sells her house for $15,000 less than what she paid for it. Can Vee take advantage of the capital loss by deducting it from her income taxes?

No - Vee cannot take a deduction for a capital loss suffered on the sale of her home. Tax deductions for capital losses apply only to property held for investment purposes and not to losses on the sale of a principal residence or other personal use real property.

TRUE or FALSE: The Chens paid $471,500 for a commercial property and made $60,000 in capital expenditures. Their adjusted basis is $531,500. Prices have climbed since they bought the property, and now it would sell for $585,000, which is $53,500 more than their basis. Since the Chens are not selling the property, the $53,500 gain in value is not yet realized, so they are NOT taxed on the gain at this point.

True - A gain isn’t taxable until it is realized. So until the Chens sell the property, they will not be required to pay taxes on the capital gains.

YES or NO: Francis is tired of living in the city and wants to move. She decides to sell her Manhattan condo and buy a little cottage in the mountains. Could this transaction be treated as a like-kind exchange?

No - To be eligible under Section 1031, only business or investment properties can be involved. Francis could not defer any capital gains taxes she might owe on the sale of her condo by exchanging it for a cottage.

YES or NO: Francois wants to sell a warehouse he owns in Seattle and buy a strip mall in Vancouver, British Columbia. Could this transaction be treated as a like-kind exchange?

No - Any investment property can be exchanged for any other investment property, except when property in the United States is exchanged for property in another country.

YES or NO: In January, Mary moved for a new job. She used the Section 121 provisions to avoid taxable gain on her home. Mary commutes 35 miles for work every day. The following March, she got a new job in another town 110 miles from her home. Can Mary invoke the Section 121 provisions again, even though her last move was less than two years ago?

Yes - Since the difference in commuting miles is greater than 50, Mary is eligible to invoke the provisions of Section 121 again, even though it has been less than two years since her last move.

YES or NO: Harvey sold his house a year ago and bought a new one when he transferred to a new job. He did not pay capital gains taxes on his old home. Harvey just learned he is very ill and will soon be unable to care for himself. He wants to sell his house and move back home to be closer to family. Will he have to pay capital gains taxes when he sells the new house?

No - Because he cannot care for himself, Harvey can invoke an exemption even though he has not resided in the new home as his principal residence for two out of the last five years.

TRUE or FALSE: A single person just sold their principal residence for $425,000, with selling expenses of $25,000. They bought the house 25 years ago for $250,000. If the seller meets all the conditions for the Section 121 exclusion, their recognized taxable gain is $150,000.

False - The seller’s realized gain is $150,000: $425,000 selling price – $25,000 selling expenses – $250,000 original cost. But because the Section 121 exclusion of $250,000 that a single person can claim is greater than the realized gain of $150,000, there is no recognized taxable gain.

TRUE or FALSE: Spouses Pat and Chris Smith sell a rental property and make a $185,000 profit. They do NOT have to pay capital gains tax on their net proceeds because the amount is below the $500,000 limit for married couples.

False - While up to $500,000 of gain is tax free for married couples every two years, this applies only to a principal residence. The Smiths sold their rental property, not their principal residence, so the exemption does not apply.

The Internal Revenue Code section that allows a taxpayer to sell an investment property and purchase another investment property in its place without paying capital gains on the proceeds from the sale.

1031 Exchange

The cost to acquire a property plus the cost of any capital improvements minus depreciation or other losses.

Adjusted Basis

The increase in value of an asset over time.

Appreciation

Extra, non-like-kind property that can be a part of a like-kind exchange to make up for pricing disparity between like-kind properties.

Boot

Profit made from an investment.

Capital Gain

A loss in property value for any reason, such as physical deterioration, functional obsolescence, or external obsolescence; also, an accounting loss in value that is used as a tax deduction for income tax purposes.

Depreciation

Any type of real estate—residential, retail, office, or industrial—from which the owner collects rent.

Income Property

Earnings derived from any business or income-producing activity in which the taxpayer does not materially participate, such as rental property.

Passive Income

Real estate other than their residence that a taxpayer owns for their own use, such as a vacation home.

Personal Use Property

The dwelling that a person inhabits most of the time.

Principal Residence

Profit that results from selling an asset for more than its original purchase price.

Realized Gain

A simple depreciation method that involves dividing the total cost of a building by the number of years the building is expected to be useful.

Straight-Line Depreciation

The expensing of the cost of business or investment property over a set number of years that the IRS has determined to be the asset’s useful life (27.5 years for residential property and 39 years for commercial nonresidential property).

Tax Depreciation