Real estate has been a lucrative investment for many years. Real estate provides greater diversification properties as compared to equity or fixed-income investments. Two important benefits to investing in real estate are the abilities to leverage investments and to decrease tax liability. Consider Beth’s case: In 2011, Beth has an adjusted gross income from one job of $50,000 (not including any deductions from real estate loss). In addition, Beth owns an apartment building that she rents out throughout the year. The revenues she received from her apartment building amounted to $150,000 in rent payments for the year. The operating expenses (maintenance, mortgage interest, and so forth) amounted to $90,000 for the year. Her income (before subtracting depreciation expenses) for the apartment building is therefore (her rental income minus her expenses). Her accountant has informed her that the apartment building can be depreciated upto $67,500 for tax purposes in 2011; therefore, she can subtract of the depreciation expense from her rental income (and thus not pay taxes on that amount). If her adjusted gross income were less than $100,000 per year, she could write off of the depreciation amount against her ordinary income. Suppose Beth is interested in purchasing an additional apartment building as an investment. She has $60,000 in cash and can borrow an additional $150,000 at an annual interest rate of 9% to purchase a property costing $210,000. If the property is expected to generate $22,680 per year after expenses, then the benefit from leveraging the investment the cost of paying interest on the loan.

ENGR.ECONOMIC ANALYSIS

14th Edition

ISBN:9780190931919

Author:NEWNAN

Publisher:NEWNAN

Chapter1: Making Economics Decisions

Section: Chapter Questions

Problem 1QTC

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Real estate has been a lucrative investment for many years. Real estate provides greater diversification properties as compared to equity or fixed-income investments. Two important benefits to investing in real estate are the abilities to leverage investments and to decrease tax liability.

Consider Beth’s case:

In 2011, Beth has an adjusted gross income from one job of $50,000 (not including any deductions from real estate loss). In addition, Beth owns an apartment building that she rents out throughout the year. The revenues she received from her apartment building amounted to $150,000 in rent payments for the year. The operating expenses (maintenance, mortgage interest, and so forth) amounted to $90,000 for the year. Her income (before subtracting depreciation expenses) for the apartment building is therefore (her rental income minus her expenses).

Her accountant has informed her that the apartment building can be depreciated upto $67,500 for tax purposes in 2011; therefore, she can subtract of the depreciation expense from her rental income (and thus not pay taxes on that amount). If her adjusted gross income were less than $100,000 per year, she could write off of the depreciation amount against her ordinary income.

Suppose Beth is interested in purchasing an additional apartment building as an investment. She has $60,000 in cash and can borrow an additional $150,000 at an annual interest rate of 9% to purchase a property costing $210,000. If the property is expected to generate $22,680 per year after expenses, then the benefit from leveraging the investment the cost of paying interest on the loan.

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