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Real Estate Investment Real Estate Investment
Chapter 6Chapter 6
Property Taxes and Income Taxes
© 2011 Cengage Learning
© 2011 Cengage Learning
Key TermsKey Terms
Active income
Ad valorem
Adjusted basis
Allocation
ARRA
Capital gain income
Cost recovery period
Depreciation
FIRREA
© 2011 Cengage Learning
Key Terms
Investment interest
Mill
Millage
Negative amortization
Passive activity income
Portfolio income
RTC
Tax assessment
Tax Reform Act
© 2011 Cengage Learning
Kinds of Taxes That Affect Real Estate
Property taxes—sometimes called ad valorem taxes, which are levied on the value of taxable property.
Income taxes—taxes on individuals and corporations based on the amount of taxable income.
© 2011 Cengage Learning
Property Taxes
Determination of Property Taxes
Budget Requirements
Appraisal
Assessment
Collection of Property Taxes
Property Tax Exemptions
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Other Property Tax Considerations
Special Assessments
Tax Revenue Bonds
Deductibility of Property Taxes
Homeowner
Business
Mortgagee
Back Taxes Paid by the Buyer
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Federal Income Taxes
Economic Recovery Tax Act of 1981 (ERTA)
Tax Reform Act of 1986Depreciation schedules changed
Component depreciation reintroduced
Reduction in marginal tax rate
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FIRREA
The Financial Institutions Reform, Recovery, and Enforcement
Act (FIRREA) was passed in 1989
The Resolution Trust Corporation (RTC) was established by FIRREA
mission is to close the failed thrifts, dispose of the seized assets (primarily real estate) and return the funds to the new insurers of the thrift industry.
RTC completed its mission by 1995
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More Legislation
Economic Growth and Tax Reconciliation Act of 2001 Jobs and Growth Tax Relief Reconciliation Act of 2003American Recovery and Reinvestment Act (ARRA) of 2009
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Business Income
Business income has many sources, and the IRS identifies a few in the following general categories for reporting purposes:
1. Gross receipts less cost of goods sold and/or cost of operations
2. Interest and dividends
3. Rental and royalty income
4. Net capital gain or loss
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Deductions from Income
Salaries and wagesManagement expensesProperty taxesRepairs and maintenanceInsuranceUtility costsDepreciationInterest
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Deductions from Income
Capitalizing an expenseIf the capitalized item is non-tangible the recovery of the cost is amortized. If the capitalized item is tangible property its recovery is taken as depreciation.
Problem Areas of DeductionsRepairs and Maintenance
Repairs vs. ImprovementsReplacement vs. Maintenance
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Interest Expense
Prepaid Interest
Investment Interest
Interest on Rollover Loans
Accrued Interest
Loan Discount
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Types of Income for Tax Purposes
Active Income
Passive Activity IncomeLimited Partners and Limited Liability Corporations
Real Estate Rental Activity Exception for Real Estate Professionals
Portfolio Income
Capital Gain Income
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Determining Capital Gain
Basis of valuePurchased propertyProperty purchased with other propertyProperty exchangesInherited property Gift PropertyProperty purchased for services renderedForeclosed property
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Adjustments to the Basis of Value
Additions to the basis of value
Reductions to the basis of valueDepreciation
Method of calculating depreciation
Cost recovery period
Residential property defined
Midmonth convention
Excluded real estate
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Realized Selling Price
Consideration ReceivedAll cash received
The fair market value of any property used as consideration or services rendered in payment
Any liabilities of the seller assumed by the buyer
Permitted selling costs
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Allocation of Land Costs and Building Costs
The purchase contract may specify the prices for major components of the property.
An appraisal by a professional gives good evidence of a proper allocation.
The taxpayer may use a property tax (ad valorem tax) assessment of the property.
