Real Estate Investing Tax Implications of Ownership 2 β Questions and Answers
Question 1: What is the maximum amount of capital gains a married couple filing jointly can exclude from the sale of their primary residence under Section 121?
- $250,000
- $500,000 (Correct answer)
- $750,000
- $1,000,000
Correct answer: $500,000
Married couples filing jointly can exclude up to $500,000 of capital gains from the sale of a primary residence under the Section 121 exclusion.
Question 2: Which IRS tax form is used to report rental income and expenses from a residential rental property?
- Schedule C
- Schedule D
- Schedule E (Correct answer)
- Form 4797
Correct answer: Schedule E
Schedule E (Supplemental Income and Loss) is used to report income and expenses from rental real estate, royalties, partnerships, and S corporations.
Question 3: How is real estate held for more than one year before sale typically taxed at the federal level?
- As ordinary income
- At long-term capital gains rates (Correct answer)
- At a flat 28% rate
- As self-employment income
Correct answer: At long-term capital gains rates
Real estate held for more than one year qualifies for long-term capital gains rates, which are generally lower than ordinary income tax rates.
Question 4: What does 'basis' mean in the context of real estate taxation?
- The annual rental income from a property
- The appraised market value at time of sale
- The original purchase price plus capital improvements (Correct answer)
- The assessed value used for property tax purposes
Correct answer: The original purchase price plus capital improvements
Basis in real estate is generally the purchase price plus the cost of capital improvements, and it is used to calculate gain or loss upon sale.
Question 5: Which of the following expenses is NOT deductible against rental income?
- Mortgage interest
- Property management fees
- Personal vacations to inspect the property (Correct answer)
- Insurance premiums
Correct answer: Personal vacations to inspect the property
Personal vacation expenses are not deductible even if the owner visits the property, as the IRS requires expenses to be ordinary and necessary business costs.
Question 6: What is the 'unrecaptured Section 1250 gain' tax rate that applies to depreciation taken on real property?
- 15%
- 20%
- 25% (Correct answer)
- 28%
Correct answer: 25%
Unrecaptured Section 1250 gain, which represents previously taken depreciation deductions on real property, is taxed at a maximum federal rate of 25%.
Question 7: A real estate investor purchases a duplex, lives in one unit, and rents the other. How are expenses typically handled?
- All expenses are fully deductible as rental expenses
- Expenses must be allocated proportionally between personal and rental use (Correct answer)
- No expenses are deductible because it is partially personal use
- Only mortgage interest is deductible
Correct answer: Expenses must be allocated proportionally between personal and rental use
When a property is used both personally and as a rental, expenses must be allocated proportionally based on the percentage of space or time used for rental versus personal purposes.
Real Estate Investing Tax Implications of Ownership 2
What is the maximum amount of capital gains a married couple filing jointly can exclude from the sale of their primary residence under Section 121?