Property Investment Glossary
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Accelerated Cost Recovery System (ACRS): Before 1981, assets used for the production of income were depreciable if they were subject to wear and tear or decline due to natural causes or obsolescence. Assets that did not decline in value on a predictable basis, such as land or stock, were not depreciable. Under the Accelerated Cost Recovery System, most real and personal property placed into service after December 31, 1980 are eligible recovery property. The system allows recovery of cost of depreciable assets at accelerated rates over periods shorter than their useful lives, with higher percentages in the early years. The cost of the property is recoverable over a 3-year, 5-year, 10-year, or 15-year period, depending on the type of property. Although the term “ACRS” is still used, accelerated depreciation is not available for real property placed in service after December 31, 1986, I.R.C. § 168(b)(3).
Accelerated Depreciation: Accelerated depreciation is a method of depreciation in which larger deductions are taken earlier in the life of the asset than with the straight-line method. Examples include the 200 percent, sum of the years-digits, 150 percent, or 125 percent methods.
Account: An account is a written record of a business transaction expressed in money and kept in a ledger.
Accounting Principles: Accounting principles refer to an accounting doctrine that explains current practices and is a guide for the selection of accounting conventions or procedures when alternatives exist.
Accrued Depreciation: Accrued depreciation is the difference between the cost of replacing new property and the present market value of the property.
Active Income: Active income is all taxable income of a taxpayer except income from a passive activity and portfolio income. Passive activity is something in which the taxpayer does not actively take part, and portfolio income is income made from investment accounts. Active income is principally from earnings. In general, only corporations may deduct losses and apply tax credits from passive activities against active income, I.R.C. § 469(a)(2), (e)(2).
Additional First-Year Depreciation Allowance: The additional first-year depreciation allowance is a depreciation allowance equal to 20 percent of the cost of certain depreciable personal property. This allowance applies only to property placed in service before January 1, 1981. See former I.R.C. § 179.
Adjusted Basis: Basis is the cost of an asset or some substitute for cost. Adjusted basis is the basis, plus or minus certain adjustments such as expenditures, receipts, losses, and depreciation, I.R.C. § 1016.
ADR System: The Asset Depreciation Range (ADR) System is a method of determining the allowance for depreciationby assessing the useful life of the property according to published guideline life ranges, I.R.C. § 167(m).
After-Tax Investment: After-tax investment is the actual cost, after tax benefits, of the investment. It is often referred to as hard dollar investment.
Alternative Minimum Tax: The alternative minimum tax is a tax that applies to taxpayers who otherwise would pay little or no tax because of the availability of various deductions and tax credits, I.R.C. § 55. The alternative minimum tax is an additional tax based on the difference between a tax on the taxpayer’s “alternative minimum taxable income” and the tax that would otherwise be imposed, I.R.C. §§ 55(a), (b). I.R.C. §§ 56-58 describes adjustments and items of tax preference taken into account in determining alternative minimum taxable income.
Appraisal: An appraisal is a written valuation of property made by a qualified independent appraiser.
Appreciation: Appreciation is the increase in value of real property due to various economic factors, such as inflation.
At-Risk Limitation on Losses: If a taxpayer sustains losses in his business, there is a limitation on the amount of losses that he may deduct to amounts for which he is personally “at risk.” The limitation is called the at-risk limitation on losses. Amounts at risk include money and property contributed to the activity and borrowed amounts for which the taxpayer is personally liable for repayment or has pledged property as security for repayment (recourse financing), I.R.C. §§ 465(b)(1), (2). The taxpayer is also at risk in regard to qualified nonrecourse financing, I.R.C. § 465(b)(6)(A). The “at risk” rule applies to losses incurred from real property placed in service by the taxpayer after December 31, 1986.
Audit: An audit is an examination of an accounting document and the evidence supporting the document in order to determine whether the accounting was properly done.
Audited Financial Statements: Audited financial statements are financial statements prepared in accordance withgenerally accepted accounting principles and accompanied by an auditor’s report, which contains an unqualified opinion of an independent certified public accountant.
Average Annual Return: The return on an investment is the amount of money given to the investor based on the gain made by the use of the invested funds. The average annual return is a method of determining the return of an investment by averaging the total cash flow over the number of years the cash flow is received by the investor.
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Balance Sheet: A balance sheet is a financial statement which shows the financial position of a business or an individual at a certain point in time.
Band of Investment Method: Capitalization rate is the rate of interest that is considered a reasonable return on the investment used in capitalization net income to determine the value of the property. The band of investment method is a method of determining the capitalization rate by apportioning the rate between a return rate on invested capital and the interest rate on outstanding loans against property.
Basis: Basis is the cost of property at the time of its acquisition. It is used under the Internal Revenue Code for the purpose of computing gain, loss and depreciation with respect to the property, I.R.C. §§ 167(g), 1011.
Basket Clause Investments: Basket clause investments are forms of equity participation investment made under insurance laws that permit exceptional kinds of financing, such as high loan-to-value ratios, second mortgages and buying subordinated fees.
Blighted Area: A blighted area is a declining area in which real property values are seriously affected by destructive economic forces. These forces include property usages not compatible with existing uses, the declining social and economic status of new residents, and rapidly depreciating buildings.
Breakeven Point: In investment analysis, the breakeven point is the level of gross income that must be met to cover the annual expenses and debt service. It is expressed as a percentage of the gross income. It reveals the maximum vacancy factor a building may stand and still “break even.”
Building Residual Technique: The building residual technique is a capitalization method in which a value for the land is assumed in determining the value of property.
Building-to-Land Ratio: Building-to-land ratio is the ratio of the value of the building to the value of the land. Real property with a low “building-to-land ratio” may not be the highest and best use of the property.
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Calendar Year: The calendar year is the twelve months beginning on January 1 and ending on December 31.
Capital Asset: As a real estate term, capital asset means property of a permanent nature which is used in the production of an income. Examples include land, buildings, machinery and equipment.
As an accounting term, capital asset means property intended for use or possession for a period longer than one accounting cycle (usually for a period of longer than one year).
As a taxation term, capital asset means all property other than specifically excluded items such as inventory and property used in trade or business, I.R.C. § 1221.
Capital Expenditure: For accounting purposes, a capital expenditure is an expenditure expected to benefit future periods.
Capitalization: Capitalization is the process of discounting anticipated future profits to present market value by use of an appropriate capitalization rate. Discounting is making an allowance or deduction from a gross sum.
Capitalization Rate: Capitalization rate is the rate of interest that is considered a reasonable return on the investment used in capitalization net income to determine the value of the property.
Cash Available for Distribution: Cash available for distribution is cash flow less the amount set aside for restoration or creation of reserves.
Cash Flow: As an investment term, cash flow means the amount of cash received annually from an investment, which is the annual net income from the property less the annual debt service on the property. Cash flow is positive if the net income exceeds the debt service. The cash flow is negative if the debt service exceeds the net income. As used in securities laws, cash flow means cash funds provided from business operations, including lease payments on net leases from builders and sellers, without deduction for depreciation, but after deducting cash funds used to pay all other expenses, debt payments, capital improvements and replacements.
Cash Flow Method: Cash flow method is a way of analyzing a potential investment by determining the percentage cash flow return on the invested capital.
Change: Change is a principle of real estate valuation that provides that conditions affecting the value of real estate are constantly changing.
Comparable Properties: Comparable properties are properties that are similar. The conditions that make properties comparable include the use of the property, the land-to-building ratio, size, rental charges, and price. The land-to-building ratio is the ratio of the land value to the building value.
Component Depreciation: Component depreciation is a depreciation technique under which the various components of a new building (for example, the roof, furnace, and electrical system) are depreciated separately rather than as portions of the cost of the building as a whole. “Component depreciation” usually results in higher depreciation deductions in the first few years of the useful life of a building.
Compound Interest: Compound interest is interest paid on original principal and also on the accrued and unpaid interest that has accumulated.
Cost Approach to Valuation: The cost approach to valuation is a method of valuing real property that is based on the theory that a potential buyer would never pay more for a particular property than it would cost to reproduce the property.
Cost Method of Valuation: The cost method of valuation is the method of determining the value of property by subtracting the estimated depreciation on the building from the cost to replace the property.
Cost of Property: The cost of property is the sum of the price paid by the seller for the property plus all costs and expenses that can be reasonably attributed to the property under generally accepted accounting principles. However, in the case of oil and gas programs, the cost of drilling wells that are not commercial producers cannot be attributed to the property.
Credit: As an accounting term, credit means a bookkeeping entry on the right side of an account recording the reduction or elimination of an asset or an expense, or the creation of or addition to a liability or item of capital or revenue.
Crossover Point: The crossover point is the time at which the rental income on a property exceeds operating expenses, depreciation and interest on the mortgage. This point usually occurs in the seventh or eighth year of the holding period of the investment.
Current Asset: A current asset is an asset which is expected to be converted into cash, other spendable assets, goods, or services within a short period of time (usually one year).
Current Liability: A current liability is a short-term debt or other debt expected to be paid out of current assets or to be transferred to income within a short period of time (usually one year).
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Dealer: As an investment term, a dealer is a person who deals in real property as an occupation rather than as aninvestor. For purposes of income taxation, a dealer is one who holds property primarily for sale to customers in the ordinary course of trade or business. A person who is a “dealer” with respect to specific property is ineligible for the benefits of long-term capital gain treatment on the disposition of the property, I.R.C. §§ 1221(1), 1231(b)(1)(B).
In federal securities law, a dealer is any person engaged in the business of buying and selling securities for his or her own account, 15 U.S.C. § 78c(a)(5).
Debit: A debit is a bookkeeping entry on the left side of an account, recording the creation of or addition to an asset or an expense, or the reduction or elimination of a liability, or item of equity or revenue.
Declining Balance Depreciation: Declining balance depreciation is a method of depreciation under which a uniform rate is applied each year to the unrecovered basis of the property. The rate is expressed as a percentage of the straight line rate, such as 150 percent. The basis of the property is decreased each year by the amount of the depreciation previously allowed or allowable, Treas. Reg. § 1.167(b)-2(a).
Demographic Factor: A demographic factor is a population factor that affects the value of real property, such as the number of persons renting as compared to buying, or an increase in the divorce rate.
Depreciation: In real estate practice, depreciation means the loss of value of real property brought about by age, physical deterioration, or functional or economic obsolescence.
For the meaning of depreciation in income taxation, refer to the following sections: Additional First-Year Depreciation Allowance, ACR System, ADR System, Component Depreciation, Declining Balance Depreciation, Salvage Value,Straight Line Depreciation and Sum of the Years-Digits Depreciation.
Deterioration: Deterioration is one of the causes of depreciation that reflects the loss in value brought about by wear and tear, disintegration, use in service and the action of the elements.
Direct Capitalization: Direct capitalization is the method of determining the value of property by dividing the net income by the capitalization rate.
Directional Growth: Directional growth is the location or direction toward which the residential sections of a city are destined or determined to grow.
Discounted Cash Flow: Discounted cash flow is a method of determining the return on an investment by deducting the cash flow from the property. See also internal rate of return and average annual return.
Distributable Cash Flow: Distributable cash flow is the net cash available from any source, including operations, sales or refinancing, distributed to participants or distributable at the option of participants in an investment group.
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Economic Base Multiplier: The economic base multiplier is the percentage increase in the secondary jobs provided by industry to a community, such as additional jobs in providing services for the employees of a new company.
Economic Benefits: Economic benefits are benefits from a real estate investment resulting from cash flow andappreciation of the property, but not including tax benefits.
Economic Life: Economic life is the period over which real property will yield a return on the investment, over and above the economic or ground rent due to the land.
Economic Obsolescence: Economic obsolescence is depreciation resulting from economic conditions, such as the deterioration of the neighborhood.
Ellwood Tables: Ellwood Tables are capitalization tables used to determine the value of an investment.
Equity: As an investment term, equity means the interest or value in real estate over and above the liens against it. Liens are charges or encumbrances on property that have to be paid off when the property is sold.
As an accounting term, equity means the interest held by owners in a business entity.
Equity Build-Up: Equity build-up is the increase in the equity in real estate investment, which is caused by the amortization of the existing loan and by appreciation of the property. Amortization is a reduction of the loan by periodic payments. Appreciation is an increase in the value of the property. The term equity build-up is often used only to refer to amortization of the loan.
Equity Growth Rate: Equity growth-rate is the rate at which equity in an investment is increasing.
Equity Return: Equity return is the rate of return on the equity in the property.
Equity Yield: Equity yield includes cash flow on the original equity investment, mortgage amortization, and the effect ofappreciation or depreciation, if any.
Excess Depreciation: Excess depreciation is the amount of depreciation deductions taken in excess of straight line depreciation.
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Fair Market Net Worth: Fair market net worth is the difference between total fair market value of assets and totalliabilities. In the case of an oil and gas group investment sponsor, fair market net worth includes the present value of reserves in oil, gas, and other minerals as determined by an appraisal by a qualified independent appraiser.
Fair Market Value: Fair market value is the price at which property would change hands between a willing buyer and a willing seller, neither being compelled to buy or to sell and both having reasonable knowledge of relevant facts. See market value.
Feasibility Study: A feasibility study is a report assessing whether or not a project can be completed. It is not an appraisal on particular real property as to the attractiveness of the property as a proposed investment
Fiscal Year: A fiscal year is a period of twelve months ending on the last day of any month other than December.
Fixed Assets: Fixed assets refers to a balance sheet classification denoting capital assets other than intangibles and long-term investments. Intangibles consist of property that is a “right” rather than a physical object. Fixed assets include property, plant and equipment.
Fixed Expenses: Fixed expenses are expenses on an income statement that represent insurance costs and property taxes.
Fixed Liability: A fixed liability is a long-term liability.
Free and Clear Return: Free and clear return means the yield from property that is arrived at by dividing net incomeby the total purchase price. It is expressed as a percentage.
Functional Obsolescence: Functional obsolescence is depreciation from faulty design or lack of modern conveniences.
Future Value Tables: Future value tables are charts used to determine the total amount at some time in the future of a lump sum deposited presently, or periodic deposits, earning interest at a given rate.
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Generally Accepted Accounting Principles: Generally Accepted Accounting Principles are rules that have widespread acceptance in the profession of accountancy.
Gross Income: In accounting, gross income is the total income from property before any expenses are deducted.
In taxation, gross income is all income from whatever source derived, except income from items and transactions specifically excluded by the Internal Revenue Code, I.R.C. § 61.
Gross Multiplier: A gross multiplier is a number that when multiplied by the gross income from real property provides the value of the property.
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Hard Dollar Investment: Hard dollar investment is the actual cost, after tax benefits, of the investment. It is also called the after-tax investment.
Highest and Best Use: Highest and best use is an appraisal phrase meaning the use of property that is most likely to produce the greatest percentage net return on the property.
Hoskold Method of Capitalization: The Hoskold Method of Capitalization is a method of capitalizing net income to determine the value of property. The method involves the creation of a sinking fund at a 3 percent rate. Seecapitalization.
Hundred Percent Location: A hundred percent location is a city retail business location that is considered the best available for attracting business.
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Income Approach: Income approach is an approach to the appraisal of real estate that determines value based on acapitalization of the income stream generated by the property.
Income Statement: An income statement is a financial statement that shows which items were included in the computation of the net income of a business or person for a specified period of time.
Inflation Hedge: Inflation hedge is the protection against inflation afforded by real estate investments due to the fact that the real estate increases in value at a rate equal to the rate of inflation.
Interest in Real Property: Interest in real property means any estate or interest in unimproved land, agricultural land, or land improved with residential, commercial, industrial or other structures. Interest in real property includes profits, rents, or other incidental income.
Internal Rate of Return Method: The internal rate of return method is a complicated method of determining the rate of return on an investment. The method involves discounting cash flow at the internal rate of return. The computations are usually made with a computer.
Investment Tax Credit: The investment tax credit is one of the credits that make up the general business credit, I.R.C. §§ 38(a), (b)(1), 46; I.R.C. §§ 49, 50. The investment credit is sum of (1) the rehabilitation credit, I.R.C. § 47; (2) the energy credit, I.R.C. § 48(a); and (3) the reforestation credit, I.R.C. §§ 46, 48(b). Under former law,the investment tax credit was a federal income tax credit allowing for a direct offset against tax of a percentage (generally 10 percent) of the basis or cost of property placed in service in connection with a trade or business. (See former I.R.C. §§ 46, 48). The investment tax credit is generally applicable to property placed in service before January 1, 1986.
Investment Interest: Investment interest is any interest allowable as an income tax deduction that is paid or accrued on indebtedness properly allocable to property held for investment, I.R.C. § 163(d)(3)(A). Investment interest is deductible by a noncorporate taxpayer only to the extent of net investment income, I.R.C. § 163(d)(1).
Investor: As an investment term, investor refers to a person who invests in real property and not to a dealer in real property.
In securities law, an investor is any person who pays with cash or other assets for an interest in a group investment in real estate and who does not participate in the management of the syndicate.
Investor Benefits: Investor benefits are the total benefits to the investor in real property. The benefits include cash flow,appreciation, and tax benefits.
Inwood Method of Capitalization: The Inwood Method of Capitalization is a method of capitalizing net income to determine the value of the property. The method assumes the creation of a sinking fund that earns interest at theinvestor’s required rate of return.
Items of Tax Preference: Items of tax preference are specified types of income and deduction that are included in taxable income in determining the applicability of the alternative minimum tax, I.R.C. §§ 57, 55.
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Land: Land includes the ground and everything attached to it. It also includes everything above and below the surface. Thus, a tract of land actually is an inverted pyramid beginning from the center of the earth and passing through the boundary lines at the surface of the earth and extending upwards.
Land Residual Technique of Capitalization: Land residual technique of capitalization is a method of capitalizationin which building value is assumed in order to determine the value of property.
Land Speculation: Land speculation is an investment technique of buying unimproved land with the expectation of a rapid growth in value.
Land-to-Building Ratio: Land-to-building ratio is the ratio of the land value to the building value.
Leverage: Leverage is the use of financing to acquire real estate investments. The amount of leverage on real property will be the ratio of the debt to the purchase price.
Liability: A liability is a debt or obligation represented by a credit balance that is or would be properly carried forward on a closing of books of account according to the rules or principles of accounting.
Liquidity: Liquidity is the ability to convert an investment to cash or its equivalent.
Loan Value: Loan value is the value determined by a financial institution as the value of the real property for loan purposes. It is not the fair market value.
Loan-to-Value Ratio: In lending practice, the loan-to-value ratio is the maximum loan permitted by federal and state regulation based on a ratio of the loan to the loan value of the property.As an investment term, loan-to-value ratio is the ratio of the existing loan to the fair market value of the property.
Location: The location of real property is composed of three components: general area, neighborhood and site.
Long-Term Capital Gain: A long-term capital gain is the amount of money gained from the sale or exchange of a capital asset held more than 12 months, I.R.C. § 1(h).
Long-Term Capital Loss: A long-term capital loss is the amount of money lost from the sale or exchange of a capital asset held more than 12 months, I.R.C. § 1(h).
Long-Term Investor: A long-term investor is an investor, such as an insurance company or pension fund, that is interested in holding property for a long period of time.
Long-Term Liability: A long-term liability is an obligation that will not become due within one accounting cycle (usually one year).
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Market Approach: Market approach is a type of appraisal for real estate that uses recent sales of comparable properties in the same area as the subject property as the basis of computing value.
Market Price: Market price is the price paid for property regardless of circumstances. It is not the same thing asmarket value.
Market Value: Market value is the price at which a willing seller would sell and willing buyer would buy, neither being under unreasonable pressure. See fair market value.
Minimum Tax for Tax Preferences: For minimum tax for tax preferences, see alternative minimum tax.
Multiplier: A multiplier is a number which when multiplied by the gross or net income provides the value of the property.
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Net Capital Gain: Net capital gain is the excess of a taxpayer’s net long-term capital gain for the taxable year over thenet short-term capital loss for the year, I.R.C. § 1222(11).
Net Capital Loss: Net capital loss is the excess of the losses from the sales or exchanges of capital assets for ataxable year over the amount of the losses that are deductible in the same year, I.R.C. §§ 1211, 1222(10).
Net Income: Net income is gross income minus expenses (excluding debt service).
Net Income Multiplier: A net income multiplier is a number than when multiplied by the net income provides the value of the property.
Net Long-Term Capital Gain: Net long-term capital gain is the excess of long-term capital gains for the taxable yearover the long-term capital losses for the year, I.R.C. § 1222.
Net Long-Term Capital Loss: Net long-term capital loss is the excess of long-term capital losses for the taxable yearover the long-term capital gains for such year, I.R.C. § 1222(8).
Net Operating Income Ratio: The net operating income ratio is the ratio of the net income to the market value of the property.
Net Operating Profits Interest: Net operating profits interest is a special class of net profits interest. It is an interest in net profits from the beginning of production without regard for expenditures on leasehold, exploration or development.
Net Present Value Approach: For net present value approach, see discounted cash flow method.
Net Short-Term Capital Gain: Net short-term capital gain is the excess of short-term capital gains for the taxable year over the short-term capital losses for the year, I.R.C. § 1222(5).
Net Short-Term Capital Loss: Net short-term capital loss is the excess of short-term capital losses for the taxable year over the short-term capital gains for the year, I.R.C. 1222(6).
Net Spendable: For net spendable, see cash flow.
Net Worth: Net worth is the excess of total assets over total liabilities.
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Occupancy Rate: Occupancy rate is the percentage of space in a building that is leased or occupied.
Operation Expenses: Operation expenses are the costs of operating real property. For investment analysis purposes, these expenses include all expenses except depreciation and income taxes.
Ordinary Gain: Ordinary gain is gain taxable at ordinary rates rather than at capital gains rates, I.R.C. § 1(a)-(e), (h).
Ordinary Income: Ordinary income is gain taxable at ordinary rates rather than at capital gains rates, I.R.C. § 1(a)-(e), (h).
Ordinary Loss: Ordinary loss is loss that is not subject to the deductibility limitations imposed on capital, theft, and other specially treated losses. Ordinary losses are fully deductible from gross income, I.R.C. § 165.
Over-Improvements: Over-improvements consist of property on which the building value is too high with respect to the land value so that the building does not represent the highest and best use of the property.
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Passive Activity: Passive activity consists of a trade or business in which the taxpayer does not materially participate, or any rental activity. Losses and tax credits from a passive activity may only be taken against the taxpayer’s aggregate income from all passive income and not against active income or portfolio income, I.R.C. § 469.
Payback Period: Payback period is the length of time that it takes to receive cash flow and other economic benefits from an investment that is exactly equal to the initial cash investment.
Payout: Payout is the point at which the gross revenues from production in a group investment project equal the sum of all costs. Costs include expenditures for leasehold, exploration, development, operation, and overhead but do not include depletion, depreciation, or income taxes.
Physical Depreciation: Physical depreciation is depreciation resulting from physical deterioration of a building.
Portfolio Income: Portfolio income is income resulting from a taxpayer’s investment activities, which may not be offset by losses and credits attributable to the taxpayer’s passive activities, I.R.C. § 469(e)(1).
Prepaid Interest: Prepaid interest is the payment of advanced interest on a loan.
Property Residual Technique Method of Capitalization: Property residual technique method of capitalization is a method of capitalization in which property is divided into its income portion and its reversion portion. This technique is the same as direct capitalization when an overall capitalization rate is applied to the entire value of the property.
Pyramiding Investments: Pyramiding investments means selling investments at a profit and reinvesting the proceeds in more expensive investments.
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Qualified Nonrecourse Financing: Qualified nonrecourse financing is money which the taxpayer borrows to buy real property which secures the loan. No person is personally liable for repayment. The at-risk limitation on losses does not apply in regard to qualified nonrecourse financing. The financing may not be convertible debt, and must be borrowed from a ”qualified person” or borrowed from or insured by a governmental instrumentality, I.R.C. § 465(b)(6).
Qualified Residence Interest: Qualified residence interest is interest paid or accrued during taxable year on either (1) ”acquisition indebtedness,” which is the amount incurred in acquiring, constructing, or substantially improving a qualified residence, I.R.C. §§ 163(h)(3)(A)(i), (B), or (2) ”home equity indebtedness,” which is the amount of indebtedness equivalent to the fair market value of the qualified residence minus the amount of acquisition indebtedness for the residence, I.R.C. §§ 163(h)(3)(A)(ii), (C). A ”qualified residence” is either (1) the taxpayer’s principal residence, I.R.C. §§ 163(h)(4)(A)(i)(I), 121, or (2) a second residence selected by the taxpayer that is either used by the taxpayer or certain categories of persons for the greater of 14 days or ten percent of the number of days during the taxable year for which the unit is rented at fair rental value, I.R.C. §§ 163(h)(4)(A)(i)(II), 280A(d)(1), or not rented by the taxpayer at any time during the taxable year, I.R.C. § 163(h)(4)(A)(iii). A taxpayer may generally deduct interest on aggregate acquisition indebtedness that does not exceed $1,000,000; however, a married taxpayer filing a separate return may only deduct interest on acquisition indebtedness that does not exceed $500,000, I.R.C. § 163(h)(3)(B)(ii). A taxpayer may generally deduct interest on aggregate home equity indebtedness that does not exceed $100,000; however, a married taxpayer filing a separate return may only deduct interest on aggregate home equity indebtedness that does not exceed $50,000, I.R.C. § 163(h)(3)(C)(ii).
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Rate of Return: Rate of return is the percentage return on the invested capital in an investment.
Real Estate: Real estate can be defined as the land and its improvements, while real property refers to the rights and benefits of ownership.
Real Estate Program: A real estate program is a tax sheltered program (usually a group investment project) that spends a certain amount of money for the acquisition and operation of real estate.
Real Property: Real estate can be defined as the land and its improvements, while real property refers to the rights and benefits of ownership.
Recapture of Depreciation: Recapture of depreciation refers to the inclusion as ordinary income of all or part ofexcess depreciation previously taken. This inclusion happens on a taxable event, such as the sale of property, I.R.C. §§ 1245, 1250.
Recapture of Investment: Recapture of investment is defined as the return of the initial capital investment. The period over which this is recaptured is referred to as the payback period.
Recapture Rate: Recapture rate is the rate of interest necessary to provide for the return of an investment. This is not the same thing as interest rate.
Recovery Property: Recovery property is property placed in service between January 1, 1981, and December 31, 1986, that is depreciated under the Accelerated Cost Recovery System as in effect prior to the Tax Reform Act of 1986.
Rehabilitation Expenditures: Rehabilitation expenditures are expenditures made to improve real property. Expenditures which were made for low-income housing after July 24, 1969, and before January 1, 1989, may be depreciated rapidly over a sixty-month period.
Renovation: Renovation is an investment technique of acquiring an older building that is in need of repairs and raising the rents after the repairs have been made.
Reserves: In a group investment, reserves are funds from the proceeds of the sale of securities that are not invested but are set aside to provide for contingent needs for cash, such as taxes and insurance, deferred maintenance, and major repairs and replacements.
Residual Technique: Residual technique is a method for determining property value on the basis of an assumed land or building value. This technique is used with any of the capitalization methods to determine the value of the property. The three capitalization techniques are the building residual technique, the land residual technique, and the property technique.
Return on Cash Investment: Return on cash investment is cash flow plus the principal payment on the mortgage.
Risk: Risk is the possibility that the invested capital in an investment will be lost. For purposes of determining the overall capitalization rate, the risk is assigned a risk factor.
Risk Factor: Risk factor is a number, such as 1.5, that is assigned to the amount of risk involved in an investment for purposes of determining the overall capitalization rate of an investment.
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Salvage Value: Salvage value is the amount of money, determined when the asset is acquired, that is estimated will be obtained on the disposition of the asset when it is retired from service by the taxpayer. Section 38 Property: Section 38 property is property eligible for the investment credit under former I.R.C. § 38. In general such property includes depreciable tangible property with a useful life of at least three years, used predominantly within the United States, which is either personal property, elevators, escalators, or other property (including real estate other than buildings and their structural components) used in the manufacturing, production, extraction, or furnishing of utilities (former I.R.C. § 48(a)).
Section 179 Property: Section 179 property is any recovery property that is also section 38 property, and that is acquired by purchase for use in a trade or business, I.R.C. § 179(d)(1).
Section 751 Property: Section 751 property consists of unrealized receivables, or accounts that have not been paid, and inventory items of a partnership. If a partner transfers his interest in a partnership, the portion of the consideration he receives in exchange for ”Section 751 property” is taxed as ordinary gain. Furthermore, certain distributions of ”Section 751 property” to a partner give rise to taxable income, I.R.C. § 751.
Section 1245 Property: Section 1245 property is property subject to the allowance for depreciation which is either (I.R.C. § 1245) personal property; certain amortizable real property; certain single purpose agricultural or horticultural structures; a storage facility used in connection with the distribution of petroleum or any primary product of petroleum; or certain other tangible property (including real property other than buildings or their structural components) used in connection with manufacturing, production, extraction, or the furnishing of utilities. A portion of any gain realized on the disposition of ”Section 1245 property” may be subject to recapture of depreciation, I.R.C. § 1245(a)(3).
Section 1250 Property: Section 1250 property is real property, other than section 1245 property, which is subject to the allowance for depreciation under I.R.C. § 1250(c). A portion of any gain realized on the disposition of ”Section 1250 property” may be subject to recapture of depreciation, I.R.C. § 1250(a).
Sensitivity Analysis: Sensitivity analysis is the examination of the change in value of an investment by changing various factors, such as the interest rate, the mortgage term, and the required equity yield.
Short-Term Capital Gain: Short-term capital gain is money that is gained from the sale or exchange of capital assets held less than 12 months, I.R.C. § 1(h).
Short-Term Capital Loss: Short-term capital loss is money that is lost from the sale or exchange of capital assets held less than 12 months, I.R.C. § 1(h).
Short-Term Investor: A short-term investor is an investor who holds a real property investment for five to ten years, when the maximum benefits of leverage can be obtained.
Soft Dollars: Soft dollars refer to that portion of funds advanced by the investor for the investment, such as prepaid interest, real property taxes, current excess depreciation, and management fees, that are deductible on the taxpayer’s personal income tax return.
Sophisticated Investors: Sophisticated investors are investors with financial or business experience who can fend for themselves in evaluating a securities offering.
Spendable Income: For spendable income, see cash flow.
Straight Capitalization: Straight capitalization is a method of determining the value of real property by including arecapture rate in the determination of the capitalization rate. The recapture rate is the necessary rate of return for the investment. The capitalization rate is the rate of interest that is considered a reasonable return on the investment used in capitalization net income to determine the value of the property.
Straight-Line Depreciation: As an appraisal term, straight-line depreciation is a sum set aside annually from income to pay the cost of replacing improvements, without reference to the interest it earns.
In taxation, straight-line depreciation refers to a method of depreciation under which the basis of property less its estimated salvage value is deductible in equal annual amounts over the period of the estimated useful life of the property.
Structuring: Structuring is the process of selecting financing and tax devices to maximize the return on an investment. It also refers to selection of investment entity.
Sum of the Years-Digits Depreciation: Sum of the years-digits depreciation is a method of depreciation under which the annual deduction for depreciation is computed by applying changing fractions to the basis of property. The numerator of the fraction changes each year to a number that corresponds to the remaining useful life of the property. The denominator, which remains constant, is the sum of all the years’ digits corresponding to the estimated useful life of the property.
Summation Method: Summation method is a method of determining the capitalization rate by adding the rates to the various factors involved, such as safety, risk, liquidity and management.
Synergism: Synergism is a term used to indicate that the value of the total investment package is greater than the value of the individual components.
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Taxable Income: Taxable income is a person’s estimated income subject to federal, state and local taxation at ordinary rates. It is reported as “taxable income” on the person’s federal income tax return without taking into consideration tax sheltered program investments.
Taxable Year: A taxable year is the period for computing and making returns of taxable income. It is usually a calendar year or fiscal year, I.R.C. § 441.
Tax Bracket: Tax bracket is the maximum rate at which a portion of a person’s taxable income would be taxed. Unless otherwise indicated, the term ”tax bracket” refers to the sum of rates for federal, state and local taxes.
Tax Deferred Income: Tax deferred income is cash flow on which no tax is presently payable because thedepreciation deduction is at least as large as the cash flow. The tax is thus deferred until the property is sold.
Tax Preference Items: Tax preference items are specified types of income and deduction that are included in taxable income in determining whether the taxpayer has to pay the alternative minimum tax, I.R.C. §§ 57, 55.
Tax Shelter: Tax shelter is the use of tax losses to offset or “shelter” income of a taxpayer. Real estate syndicates are referred to as ”tax shelters” when they ”shelter” at least a portion of their income from taxation. However, often the term is used only to refer to syndicates that generate a tax loss. For investors for whom the syndicate is a passive activity, a real estate syndicate’s function as a tax shelter is limited. Losses and tax credits generated by the program may only be used by the passive investor against his or her aggregate passive income, I.R.C. § 469.
Tax-Sheltered Program: A tax-sheltered program is group investment project that provides for tax benefits that flow to the investors, regardless of the structure of the legal entity or vehicle for distribution including, but not limited to, oil and gas programs, real estate syndications, citrus grove developments, cattle programs and all other programs of a similar nature, regardless of the industry represented by the program. Excluded from this definition are real estate investment trusts, tax qualified pension and profit-sharing plans pursuant to I.R.C. §§ 401 and 403(a), tax-sheltered annuities pursuant to the provisions of I.R.C. § 403(b), and mutual funds registered pursuant to the Investment Company Act of 1940. Investors for whom the program is a passive activity receive only limited flow-through tax benefits. Losses and tax credits generated by the program may only be used by the passive investor against his or her aggregate passive income, I.R.C. § 469.
Timing: For investment purposes, timing refers to the necessity of buying investment property when prices are low and disposing of the property when prices are high.
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Under-Improvements: Under-improvements refers to property on which the building value is too low with respect to the land value so that the building does not represent the highest and best use of the property.
Unrealized Receivables: For purposes of partnership income taxation, unrealized receivables are any rights of a partnership to payment, not previously included in partnership income for: (1) goods, to the extent the proceeds from sale would be taxed as ordinary income; (2) services; (3) Section 1245 property, to the extent that gain realized from the sale of such property by the partnership would be taxed as ordinary gain; (4) Section 1250 property, to the extent that gain realized from the sale of such property by the partnership would be taxed as ordinary gain; or (5) certain mining and farm property, I.R.C. § 751.
Urban Property: Urban property is city property or closely settled property.
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Valuation: Valuation is the act of valuing real property.
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Working Capital Ratio: Working capital ratio is the ratio of the total current assets of a business entity to its totalcurrent liabilities. The ”working capital ratio” is used as an indication of the short-term financial soundness of a business.
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Yield: Yield is the return of an investment. Unless otherwise specified in a syndicate offering, the term will mean the annual cash flow return on the total investment.
Yield on Cash Investment: Yield on cash investment is the same thing as return on cash investment, which is cash flow plus principal payment on mortgage.
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