Real Estate Economics

1. Real Estate Economics Chapter 11 Investments Page 52

2. Chapter 11Real Estate Investments, Part I • Macroreal estate economics studies the forces that influence general real estate markets. • Micro real estate economics studies an individual parcel of real property. • Real estate appraisal • Technical expertise of a licensed appraiser • Real estate investment • Income tax aspects Page 52

3. The Appraisal Process

5. Definitions • Real estate dealer: makes a living buying and developing real estate as an inventory to be resold to customers. • Real estate investor: holds real property for personal investment reasons, not for quick sale profit. • Investor has > tax advantages then dealer Page 52

6. Check Yourself Dealer Investor • Person who holds property for resale • Frequent sales • Occasional sales • No investment in real estate • Sales after subdividing • Property used in trade or business • Owner’s major source income from sales • Advertising for sale • Sale profits not major income source • Purchaser sought seller • Sale for purpose of liquidation of investment

7. Investment • Definition: Giving up present consumption in exchange for future benefits. • For every dollar invested, • The investor gives up a dollar’s • Worth of current goods and services Page 52

8. Definitions Page 52 • Yield: the amount of cash returned by an investment, after expenses • Tax advantages: the savings from paying less tax • Growth: the appreciation in value as a hedge against inflation • Risk: the danger of loss in value of the asset and/or the likelihood of getting the money back • Leverage: the ratio of money borrowed to personal cash invested • Management: the supervision needed to oversee the investment • Liquidity: refers to how fast the asset can be converted to cash Page 53

9. Why give up present consumption? Why not go to the mall and spend? Reasons for investing Appreciation More income at later date Save on income taxes Why Invest?

10. Real Estate Mutual Fund Insurance Bonds Savings Gold Stocks Notes

11. Major Income Tax Advantages for PrimaryResidence Interest on Loans to Purchase or Improve Home is Deductible ($1 million CAP) Equity loan up to $100,000 deductible Property Taxes are Deductible Exclude capital gains on resale $250,000 for one person $500,000 for married, filing jointly Must own & live in home 2 of last 5 years Can use once every 2 years Page 53

12. Primary Residence • Penalties if residence sold was owned less than two years. • All previous age limits & requirements to buy another home were eliminated.

13. Calculating Gain-Sale of Home • Step 1: Compute Adjusted Cost Basis Original Cost Basis (purchase price) + Capitalized Buyer’s allowable Closing Cost (Expenses) + Capital Improvements Added (not repairs or decorating) - Gain deferred Previous Sale (if any under pre May 1997 law) Equals: Adjusted Cost Basis • Step 2: Compute the Taxable Gain from the Sale Gross Resale Price - Seller’s allowable closing costs (Expenses) - Adjusted Cost Basis from Step #1 Equals: Indicated Gain From the Sale

14. Major Income Tax Advantages for Investment Property Owners Deductibility of interest on loans Deductibility of property taxes Repairs, maintenance, management, insurance + Other operating expenses are deductible. Depreciation deduction on improvements to shelter income. Long-term capital gains treatment on resale. Tax-deferred IRC 1031 exchange. Installment sale provisions. Page 53

15. Depreciation • Depreciation deduction now called Cost Recovery • Depreciation is the only “non-cash” deduction • Depreciation is an annual bookkeeping deduction allowed by IRC as a cost recovery for loss in value of the property asset over time. • Depreciation is not allowed on land. Page 53

16. Calculating Depreciation • Step #1: Determine basis • Step #2: Allocate basis between the value of the land and the improvement • Step #3: Select the current depreciation schedule method allowed by law Page 53

17. Calculating Gain on Sale of Investment Property Step 1: Determine Adjusted Cost Basis Original Cost (purchase price) + Capitalized Buyer’s closing costs + Capital Improvements - Depreciation Taken Equals: Adjusted Cost Basis

18. Step 2: Compute Taxes Owed on the Sale 1.Gross Resale Price 2. Less: Seller’s costs of sale (selling expenses 3. Less: Adjusted Cost Basis (Step #1) 4. Equals: Indicated (Realized) Gain 5. Less: Suspended Passive Losses, if any 6. Equals: Gain prior to Recapture 7. Less Depreciation Recapture 8. Equals: Gain Subject to Standard Capital Gains 9. Times: Long Term Capital Gains Rate (20%) 10. Equals: Standard Capital Gain Tax 11. Depreciation Recapture (Line 7) 12. Times: Depreciation Recapture Rate (25%) 13. Equals: Depreciation Recapture Tax 14. Plus: Standard Capital Gain Tax (Line 9) 15. Equals: Estimate Tax Owed on Resale Calculating Gain on Sale of Investment Property

19. 1031 Tax Deferred Exchange • Internal revenue code 1031: A way to move ownership from one income property to another and not recognize taxable gain. • Used by investors, not homeowners • Equity in one property is rolled subsequently to like-kind properties. • Taxes are deferred, as if NO sale. • Exchange is treated as if it is not a sale. • Not a taxable event at the time of the sale • Receipt of property received that is unlike property is called boot and is taxable. Page 54

20. Installment Sales • The seller must “carry back” financing on behalf and benefit of the buyer. • The carry back loan must have a due date in a future year, other than the year of sale. • The gain is spread out over more than one year. • The tax is due upon receipt of that portion of the principal received. Page 54