Test 8: Investments; Taxation; Ethics

negative leverage.

Leveraging is borrowing funds in order to make an investment that is larger than your own resource permits you to do directly. In negative leverage situations, your cost of borrowing funds to make the investment becomes greater than the income the investment returns to you.

income properties.

Cost recovery, or depreciation, allows the owner of income property to deduct a portion of the property’s value from gross income each year over the life of the asset. Principal residences cannot be depreciated (unless portions are treated as a home office.) Further, land cannot be depreciated.

19.5 %.

Appreciation amount is the current value of the property minus the original cost. The total appreciation rate is derived by dividing the appreciation amount by the original cost. Subtract the estimated current market value from the price originally paid (239,000 – 200,000 = 39,000) and then divide the result by the original price (39,000 / 200,000 = . 195 or 19.5%).

a deduction for mortgage interest.

Deducting mortgage interest is a significant tax advantage of owning one’s residence. Depreciation and cost-deductions do not apply to a non-income producing residence. Appreciation is a benefit, but not a tax benefit.

$232,900.

The figure for net proceeds from sale is expressed by the formula: sale price – costs of sale = net proceeds. Thus $250,000 – (6% x 250,000) – 600 – 1,500 = $232,900.

$471,000.

The beginning basis is the cost of acquiring a property. Basis is increased by capital improvements and decreased by depreciation. The basic formula for adjusted basis is Beginning basis ($450,000) + capital improvements ($9,000 + $12,000) – depreciation ($0) = adjusted basis ($471,000).

$68,000.

The gain on sale (capital gain) of a primary residence is represented by the basic formula: amount realized (net sales proceeds, $420,000) – adjusted basis ($352,000) = gain on sale ($68,000). Note the purchase price of the second house is irrelevant.

There is no taxable gain.

There is no taxable gain because the gain falls under the exclusion limit of $250,000. As of August 5, 1997, tax law provides an exclusion of $250,000 for an individual taxpayer and $500,000 for married taxpayers filing jointly on the gain from sale of a principal residence. The seller must have owned the property for at least two years during the five years preceding the date of sale; used the property as principal residence for a total of two years during that five-year period; and have waited two years since the last use of the exclusion for any sale.

direct investment.

Individuals, corporations, or other investor entities may invest as active investors in a property by buying it directly and taking responsibility for managing and operating the property. This investment mode is called direct investment.

$2,100.

Annual gross operating income ($1,500 x 12 = $18,000) – annual operating expenses ($500 x 12 = $6,000) = annual net operating income ( $12,000); annual net operating income ($12,000) – cost recovery expense ($5,000) = taxable income ($7,000); taxable income ($7,000) x tax rate (30%) = tax liability ($2,100).

the more the investor stands to gain, the greater the risk that the investor may lose.

The general rule in investments is that the safer the investment, the more slowly it gains in value. The more you want it to gain, and the more quickly, the more you must risk losing it. Reward in investing corresponds directly to the degree of risk.

income and tax benefits.

The basic financial rewards of an investment include income, appreciation in asset value, positive borrowing leverage, and tax benefits.

relatively illiquid.

Real estate is by nature more difficult to convert to cash than many other types of investment. Compare the selling of a home with the ease of drawing money out of a bank account or selling a stock.

a more management-intensive investment.

Real estate tends to require a high degree of investor involvement in management of the investment. Even raw land requires some degree of maintenance to preserve its value. Improved properties often require extensive management, including repairs, maintenance, onsite leasing, tenant relations, security, and fiscal management.

a general partnership.

A general partnership is a syndicate in which all members participate equally in managing the investment and in the profits or losses it generates.

ross income minus expenses minus building depreciation.

Taxable income from investment real estate is the gross income received minus any expenses, deductions or exclusions that current tax law allows. Depreciation of land is not allowed.

deduct interest payments from income.

Taxable income is net operating income minus all allowable deductions. The interest portion of debt service is allowed and is deducted from Net Operating Income as interest expense. Principal repayment is not an allowable deduction on investment properties. Capital gain derivation does not involve interest or principal payments.

The owner may be able to avoid capital gain tax when the property is sold.

Provided the owner meets certain ownership and use tests, there is no capital gain tax on sale of the property unless the gain exceeds $250,000 for a single taxpayer or $500,000 for married taxpayers who file jointly. Since the property is not used for business, deductions for expenses against income are not allowed.

may be deducted from the sale price for gains tax purposes.

Selling costs include such expenses as brokerage commissions, relevant advertising, legal fees, seller-paid points and other closing costs. These costs are deducted from the selling price to get the amount realized, which is reduced by the adjusted basis to calculate gain on sale for gains tax purposes.

the difference between amount realized and adjusted basis.

The formula for gain tax is Taxable Gain on Sale x the owner’s marginal tax bracket. The formula for gain on sale is: Amount Realized – Adjusted Basis = Gain on Sale. The formula for Amount Realized is: Selling Price – Selling costs = Amount Realized. Therefore, the gain tax = (Amount Realized – Adjusted Basis) x tax rate.

A tax district.

Real estate property taxes are imposed by ‘taxing entities’ or ‘taxing districts’ at county and local levels of government. States may legally levy taxes on real property, but most delegate this power to counties, cities, townships and local taxing districts. The federal government does, however, tax income derived from real property and gains realized on the sale of real property.

properties owned by a government agency.

Certain types of property are exempt from property taxes. Certain classes of property owner may also be exempted or have a reduced liability. Exemptions include government-owned properties, real properties owned by churches, and properties owned by other non-profit organizations.

It adjusts assessments in a locality to make them more consistent with an average level for the state or other higher level jurisdiction.

Equalization factors level out the unevenness of valuations for groups of properties. For instance, if assessed values of properties in one county are consistently ten percent below the average for other counties, an equalization board may multiply each assessed value in that county by a factor of 110% to raise them to the average level for the state.

$2,000,000,000.

The mill rate = (tax requirement / the tax base). A mill is one one-thousandth of a dollar ($.001). To solve for the tax base, reconfigure this formula to be: Base = Tax Requirement / Mill Rate. Thus the Base = $20,000,000 / .010, or $2,000,000,000.

$1,323.

The library tax is ($1.00 x 441) and the fire district tax is ($2.00 x 441). Thus the tax is $441 x $3 = $1,323.

$5,700.

Special assessments are based on the cost of the improvement and apportioned on a pro rata basis among benefiting properties according to the value that each parcel will receive from the improvement. Here, Mary’s share is 38 / 200, or 19%. 19% x $30,000 = $5,700.

A conveyance instrument for a property that is sold to enforce a tax lien.

A tax deed is a legal instrument for conveying title when a property is sold for non-payment of taxes. The application for a tax deed causes the taxing agency to institute a tax sale or tax foreclosure.

a statutory right of redemption.

If the taxpayer can redeem the property after the tax sale, this right is known as a statutory right of redemption. In this case, the taxpayer must pay the amount paid by the winning bidder at the tax sale, plus any charges, additional taxes, or interest that may have accumulated.

the total of all assessed values of properties minus exemptions.

The tax base of an area is the total of the appraised or assessed values of all real property within the area’s boundaries, excluding partially or totally exempt properties such as those owned by the government or non-profit organizations.

multiplying each district’s tax rate times the taxable value of the property.

Each property owner’s tax bill is determined by multiplying the tax rate for each taxing district times the taxable value of the property. Taxable value is the assessed value after all exemptions and adjustments have been taken into account.

Civil Rights Act of 1866.

The original fair housing statute, the Civil Rights Act of 1866, prohibits discrimination in housing based on race. The prohibition relates to selling, renting, inheriting, and conveying real estate

race, color, religion, and national origin.

Title VIII of the Civil Rights Act of 1968, known today as the Fair Housing Act, prohibits discrimination in housing based on race, color, religion, or national origin.

Advertising a property as available to individuals of a particular race.

The prohibition against discriminatory advertising states that an agent may not advertise residential properties in such a way as to restrict their availability to any prospective buyer or tenant.

An agent persuades a family to put their house on the market because ethnic minority families are beginning to move into the neighborhood.

Blockbusting, a prohibited activity, is the practice of inducing owners in an area to sell or rent to avoid an impending change in the ethnic or social makeup of the neighborhood that will cause values to go down.

The Home Mortgage Disclosure Act.

The Home Mortgage Disclosure Act requires lenders involved with federally guaranteed or insured loans to exercise impartiality and non-discrimination in the geographical distribution of their loan portfolio. In other words, the act is designed to prohibit redlining, the practice of restricting loans by geographical are(a)

privately owned single-family residences listed with a broker.

Among the circumstances where the Fair Housing Act might allow for an exemption is: a privately owned single-family home where no broker is used, with certain additional conditions. In other words, as soon as a broker is used in the sale, the law applies.

illegal, because the agent changed the terms of the sale to discourage this particular couple.

The Fair Housing Act prohibition against discriminatory misrepresentation states that an agent may not conceal available properties, represent that they are not for sale or rent, or change the sale terms for the purpose of discriminating.

The owner of a duplex who resides in one of the units refuses to rent the other unit to a non-Christian.

The Fair Housing Act would exempt the owner in this situation because it involves rental of an apartment in a 1-4 unit building where the owner is also an occupant and there is no discriminatory advertising.

File a complaint with HUD and/or file suit against the offending parties in a state or federal court within the prescribed time period.

The Fair Housing Amendments Act of 1988 prohibits discrimination based on sex. If May feels she has been discriminated against in this way, she may file a complaint with the Office of Fair Housing and Equal Opportunity (OFHEO) in HUD within one year or file suit in a federal or state court within two years of the alleged violation.

Inform Scott that the condition is illegal and that she cannot comply with it.

Scott is not allowed to discriminate based on race, color, religion, national origin, sex, family status, or handicap. If an agent goes along with a client’s discriminatory act, the agent is equally liable for violation of fair housing laws. It is thus imperative to avoid complicity with client discrimination. Further, an agent should withdraw from any relationship where client discrimination occurs.

require families without children to pay the same security deposit that families with children must pay.

Fair housing laws prohibit discriminatory advertising, discrimination on the basis of national origin, discrimination based on age in dwellings of more than four units, and discrimination against families with children. The fact that the owner is requiring the same deposit from tenants with and without children does not discriminate against families with children but actually favors them.

It is a single-family house, and the owner owns only one other rental home in addition to his own residence.

Federal fair housing laws do not prohibit age and family status discrimination in residential dwellings of four units or less and in single family houses if sold or rented by owners who have no more than three houses.

the Fair Housing Amendments Act of 1988.

The Fair Housing Amendments Act of 1988 prohibited discrimination based on sex and discrimination against handicapped persons and families with children. Executive Order 11063 concerned racial discrimination in housing where federal funding was involved; the Civil Rights Act of 1968 concerned discrimination based on race, color, religion, and national origin; Jones v Mayer concerned racial discrimination.

steering.

Steering is the illegal practice of limiting customers’ choices by encouraging or discouraging them about the suitability of an area and directing them only to areas the agent deems suitable for them.

providing unequal services.

The agent may be illegally providing unequal services by altering the nature or quality of brokerage services to a party based on race, color, sex, national origin, or religion.

discriminatory misrepresentation by omission.

Discriminatory misrepresentation is the concealing of available properties, representing that they are not for sale or rent, or changing the sale terms for the purpose of discriminating.

love letter.
Buyers sometimes try to enhance the attractiveness of a purchase offer by attaching a personal note to the
offer. This appeal to the seller, called a “love letter,” typically mentions such things as why the buyer
particularly likes the home, how the buyer imagines family life in the home, and how well the buyer will
care for the home.

By requiring the wholesaler to have a real estate license

Some states require the wholesaler in such transactions to hold a real estate license.