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Landlord's Income Tax Quiz

Answers & Explanations

1. Mortgage payments for a rental are: A. Not deductible B. Partially deductible C. Deductible in full D. A form of criminal extortion		B. Mortgage payments consist of two parts: principal and interest. The interest portion is a deductible expense, but the principal is not. Instead, principal is recovered through depreciation.
2. Rent unpaid by the tenant is: A. Not deductible B. Deductible as "bad debt" C. Deductible as "rent", with "–" sign D. Deductible as "entertainment"		A. You can only deduct something that you paid for. In case of unpaid rent, you did not pay anything extra, therefore no deduction. On the other hand, if you did not receive rent, your taxes do go down anyway. Why? Because you did not receive what would've been taxable income. The rule is actually fair.
3. Depreciation is: A. A "free" extra deduction for landlords B. Optional, you don't have to use it C. "Returned" when you sell the property D. A serious medical condition		C. This is a difficult question. Depreciation is not "free", because the deduction is somewhat temporary. When you sell the property, most of the benefits from prior depreciation are reversed, due to the "depreciation recapture" rules. A logical question then would be - why bother with depreciation, if it has to be reversed at the end? Because of a cruel rule that forces you to return depreciation either way - whether you used it or not! So, in theory, using depreciation is kind of optional. However, ignoring it is not smart: you will end up "returning" benefits that you never used.
4. Depreciation starts: A. On the day of closing B. On the day of "ready for rent" C. On the day 1st lease is signed D. On the day 1st tenant moves in		B. The fact that most investors believe "A" to be the correct answer does not make it correct. Depreciation starts when the property is first "placed in service." You don't have to wait for the tenant to move in, but you do have to wait until the property is fixed and ready to be occupied. Please note that the "ready" date can be the same as the closing date, but it also can be either earlier or later.
5. Cost of a new roof is deducted: A. Immediately as "repairs" B. Immediately as "advertising" C. Through 5-year depreciation D. Through 27.5/39-year depreciation		D. Sorry for the bad news, but any structural component of a building must be depreciated in the same fashion as the building itself. For residential real estate, it means 27.5-yr depreciation; for commercial property - 39 years.
6. Cost of your own labor is: A. Never deductible B. Depreciated over 27.5/39 years C. Deductible in full, as "wages" D. Deductible in full, as "other"		A. Another rule that appears to be unfair, however it does make sense when you think about it. It is true that, if not doing the job yourself, you would've had to hire help and deduct the cost of their labor. Then how is your own labor different? Simple: you do not actually pay yourself. And, as you remember from question #2, if you don't pay, you don't have a deduction.
7. New dishwasher can be deducted: A. In full, as "repairs" B. In full, as "section 179" depreciation C. Over 5 years D. Over 27.5 years		C. Appliances cannot be deducted in full, unless they were repaired and not replaced. Just like most other business assets, they must be depreciated. Fortunately, the depreciation is not too harsh - it takes 5 years, and you can use the biggest portion during the first 2 years. And what about "section 179" depreciation that allows businesses to deduct the total cost in the 1st year? Unfortunately, it does not apply to rental ("passive") businesses.
8. Receipt or other proof is required: A. For entertainment & travel expenses B. Only for expenses paid in cash C. Only for major (over $250) expenses D. For all business expenses		A. Possibly the hardest question on this quiz. All business expenses must have supporting "records", which is not the same as "receipts." For most expenses under $75, receipts are not required. However, there are a few specific kinds of expenses that must have a proof. Among those "special" categories are travel and entertainment. Whether you paid cash or not does not affect these rules.
9. Closing costs are deductible: A. Never B. In small amounts, over many years C. Up to the amount of cash at closing D. In full, in the year of closing		B. Contrary to what "everyone is doing", most of the closing costs cannot be deducted right away. When you study your closing statement, you will notice two kinds of costs: those related to purchasing (such as title policy and various fees) and those related to financing (points and credit report). The purchase-related costs should be added to the cost of the property and then depreciated. Financing-related costs must be "amortized" (evenly spread) over the length of the loan. In either case, these rules force you to stretch the deduction over very long periods.
10. Initial rehab of a foreclosure property: A. Always deductible in full, as "repairs" B. Part repairs, part depreciable improvements C. Must be slowly depreciated D. Is a popular Mardi Gras activity		C. If you answered "B", you are not too wrong. Some of the restoration costs would normally qualify as repairs (deductible), while others must be treated as improvements (depreciable). However, the tax law requires that repairs done as part of a large remodeling project are combined with the improvements and treated as one big "improvement." This is bad for your taxes, so you should do some careful planning to protect the tax benefits of repairs.