Unit 3
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Boot
Cash or other non-real-property consideration received in a like-kind exchange (1031 exchange) when the properties exchanged are not of equal value. Boot is taxable in the year received.
In a 1031 exchange, an investor trades a $400,000 rental property for a $350,000 property and receives $50,000 cash as boot. The $50,000 is recognized as taxable gain.
Capital Gains
The profit realized from the sale of a capital asset, such as real estate. Federally, primary residence capital gains may be excluded up to $250,000 (single) or $500,000 (married) if ownership and use tests are met.
A homeowner sells their primary residence in Illinois for a $180,000 profit after living there for 3 years. They qualify for the capital gains exclusion and owe no federal tax on the gain.
Coinsurance Clause
A provision in property insurance policies that requires the insured to carry coverage equal to a specified percentage (usually 80% or 90%) of the property's replacement cost. Underinsurance results in reduced claim payouts.
A home with $300,000 replacement cost is insured for only $200,000 (67%). When a $50,000 fire loss occurs, the coinsurance clause reduces the payout because coverage was below the required 80%.
Equity
The owner's financial interest in real property; calculated as current market value minus outstanding mortgage balance and other liens. Equity builds through appreciation and principal payments.
A homeowner's house is worth $350,000 with a remaining mortgage of $220,000. Their equity is $130,000, which can be accessed through a home equity loan or line of credit.
Homeowners Insurance
A package policy that protects homeowners against losses from fire, theft, liability, and other perils. It typically includes dwelling coverage, personal property, liability, and additional living expenses. In Illinois, lenders require it for mortgaged properties.
A family in Bloomington purchases an HO-3 policy that covers the structure for $280,000, personal belongings for $140,000, and provides $100,000 in personal liability coverage.
Liability Coverage
The portion of a homeowners or other insurance policy that protects the insured against claims for bodily injury or property damage to others. It covers legal defense costs and settlements up to policy limits.
A guest slips on an icy walkway at a homeowner's property in Illinois and sues. The liability coverage portion of the homeowners policy pays for the legal defense and any settlement up to the policy limit.
PITI
Principal, Interest, Taxes, and Insurance — the four components of a typical monthly mortgage payment. PITI represents the total housing cost for budgeting and qualification purposes.
A borrower's monthly PITI payment is $1,850: $1,200 principal and interest, $350 property taxes, and $300 homeowners insurance. Lenders use PITI to calculate debt-to-income ratios.
Policy
A written contract between an insurance company and the insured that outlines coverage, exclusions, conditions, and premiums. In real estate, it most commonly refers to a homeowners insurance policy.
The insurance policy for a new home purchase must be in place at closing with the lender named as mortgagee to protect the collateral.
Replacement Cost
The cost to rebuild or repair a structure using current materials and labor prices, without deducting for depreciation. Most homeowners policies insure the dwelling on a replacement cost basis rather than actual cash value.
A 20-year-old home has a market value of $250,000 but a replacement cost of $320,000 due to increased construction costs. Insurance should be based on the higher replacement cost to avoid coinsurance penalties.