Question

Real Estate Investment Returns. Marianne Mooney, benefits manager and her sister, Laureen, a middle-school teacher from Pompano Beach, Florida, are interested in the numbers of real estate investments. They have reviewed the figures in Table 16-2 and are impressed with investing together on a 50/50 basis to earn the potential 50.12 percent return after taxes. Assume that they bought the property with each contributed half of the down payment and they financed it with a 7 percent $175,000 30-year mortgage loan with annual interest costs of $11,900. Answer the following questions to help guide their investment decisions:

(a)Substitute the Maureen’s 25 percent marginal tax bracket (Florida has no state income tax) in Table 16-2, and calculate her taxable income and return after taxes.

(b)Substitute Laureen’s 15 percent tax rate (no state income tax) in Table 16-2, and calculate her taxable income and return after taxes.

(c)Why does real estate appear to be a favorable investment for Marianne and Laureen?

(d)What one factor might be changed in Table 16-2 to increase their returns?

Table 16-2

Interest Paid on Income Taxes Also Increases Investor’s Return

Gross rental income	$24,000
Less annual depreciation deduction	−6,182
Subtotal	$17,818
Less interest expense for the year (5 percent, $175,000 mortgage)	−7,900
Taxable income	$9,918
Cash flow after paying interest ($24,000 – $7,900)	16,100
Less income tax liability (0.36 × $9,918)	−3,570
After-tax return ($16,100 – $3,570)	$12,530
After-tax yield [$12,530 ÷ ($200,000 – $175,000)]	50.12%

Answer 1

Answer-

Investment decisions for Maureens and Laureens will be taken after considering the given factors mentioned below in the table.

	Maureens	Laureens
Gross Rental Income	12000	12000
Less annual depriciation deduction	3091	3091
Subtotal	8909	8909
Less Interest Expense at 7%	5950	5950
Taxable Income	2959	2959
Cashflow after paying interest (12000-5950)	6050	6050
Less Income tax Liablity	740	444
After Tax Returns (Taxable Income- Tax Liability)	2219	2515
After Tax Yield ($12000+($200,000-$175,000)	17.75%	20.15%