Ch5. Real Estate Land Use, Zoning, and Taxation — US License Exam

2nd-Portion Exam Strategy

State exam section covers land use and taxation heavily. National exam also tests these:

National Exam:
Land use controls and zoning:    ~10–15%
Real estate taxation:            ~10–12%
Environmental concerns:          ~5–8%

State Exam (additional state-specific):
State transfer tax / documentary stamps: prominent
Local property tax procedures:           prominent
State zoning enabling acts:              prominent

Strategy: Learn federal zoning and taxation principles from the national section; then memorize your state’s specific tax rates and classification systems for the state section.

Zoning and Land Use Controls

Overview of Public Land Use Controls

The government’s power to regulate land use derives from three constitutional powers:

Police power — zoning, building codes, environmental regulations (no compensation)
Eminent domain — government taking of private property for public use (just compensation required — 5th Amendment)
Taxation — property taxes and special assessments
Escheat — property reverts to the state if owner dies without heirs or a will

Zoning Classifications

Zoning ordinances divide a jurisdiction into districts. Common classifications:

Residential Zones:
R-1 (Single Family), R-2 (Low Density), R-3 (Multi-Family)

Commercial Zones:
C-1 (Neighborhood Commercial), C-2 (General Commercial)
Office/Professional, Retail, Hotel/Motel

Industrial Zones:
I-1 (Light Industrial), I-2 (Heavy Industrial)
Business Parks, Warehouse / Distribution

Special Purpose:
Agricultural, Open Space / Conservation, Flood Plain, Historic District

Key Zoning Concepts (Heavily Tested)

Building Coverage Ratio (equivalent to building-to-lot ratio):

Coverage Ratio = Building Footprint / Lot Area × 100%

Floor Area Ratio (FAR):

FAR = Total Gross Floor Area / Lot Area
Example: FAR 2.0 on a 10,000 sq ft lot allows 20,000 sq ft of total floor area

Setbacks: Minimum distances required between structures and lot lines (front, rear, side).

Nonconforming Use: A use that lawfully existed before a new zoning ordinance was enacted but no longer complies. Protected as a “grandfathered” use — may continue but cannot be expanded.

Variance: Permission to deviate from zoning requirements where strict compliance would cause undue hardship. Granted by a Board of Zoning Appeals or Zoning Board of Adjustment.

Conditional Use Permit (CUP) / Special Exception: Allows a use not otherwise permitted in a zone under specific conditions (e.g., a church in a residential zone).

Spot Zoning: Zoning a single parcel differently from surrounding parcels for the benefit of the owner — generally considered illegal and void.

Development Approvals

Building Permit:
Required before construction of any structure (typically)
Issued by local building department
Certificate of Occupancy (CO):
Issued after inspection confirms code compliance
Required before a building can be legally occupied

Subdivision Approval:
Dividing land into two or more lots requires plat approval
Must satisfy dedication requirements (roads, utilities, parks)

Environmental Impact:
NEPA (National Environmental Policy Act) — requires EIS for federal projects
State mini-NEPAs for major private developments

Environmental Concerns in Real Estate

Environmental hazards are a frequently tested category:

Hazard	Key Facts	Disclosure
Lead paint	Homes built before 1978; disclosure required	Mandatory federal disclosure
Asbestos	Common in pre-1980 construction; disturbing it releases fibers	Disclose if known
Radon	Radioactive gas from soil; elevated in basements	Disclose if tested
Mold	Moisture-related; health risk	Disclose if known
Underground storage tanks (UST)	Oil/gas contamination risk	Must disclose
Wetlands	Federal protection (Clean Water Act Section 404); development restrictions	Must check; restricts use
CERCLA (Superfund)	Liability for hazardous waste cleanup — may attach to property	Title search essential

Real Property Taxation

Property Tax (Ad Valorem Tax)

Ad valorem means “according to value.” Property taxes are assessed by local governments (county, city, or special district) based on the assessed value of real property.

Property Tax Formula:
Property Tax = Assessed Value × Tax Rate (Mill Rate)

Assessed Value = Market Value × Assessment Ratio
(Many jurisdictions assess at less than 100% of market value)

Mill Rate: $1 per $1,000 of assessed value
1 mill = 0.001 = $1 tax per $1,000 assessed value

Example:
Market Value: $400,000
Assessment Ratio: 80%
Assessed Value: $400,000 × 80% = $320,000
Mill Rate: 25 mills = 2.5%
Tax: $320,000 × 2.5% = $8,000/year

Assessment and Equalization

Assessor: The government official who determines assessed values
Equalization: Adjustment to bring assessments in line with market values across a jurisdiction
Assessment appeal: Property owners may appeal their assessed value to the Board of Equalization or similar body

Exemptions and Abatements

Common property tax exemptions:

Homestead exemption: Reduction for owner-occupied primary residences
Senior citizen exemption: Reduced assessment for qualifying seniors
Veteran exemption: Reduction for qualifying veterans
Agricultural exemption: Lower assessment for farmland in active use
Nonprofit / religious exemption: Full exemption for churches, schools, charities

Property tax liens are superior to all other liens — including mortgages. If property taxes become delinquent, the government can foreclose and extinguish junior liens (including the first mortgage).

Delinquency process (varies by state):
Tax lien attaches → Delinquency notice → Tax sale advertisement
→ Tax sale (investor purchases the tax lien or the property)
→ Redemption period (owner may redeem by paying taxes + interest)
→ If unredeemed → Tax deed issued to purchaser

Special Assessments

A charge against property for a public improvement that directly benefits the property — not based on value:

Examples: sewer installation, sidewalk construction, street paving, water line connection fees.

Special assessments are typically one-time charges; they do NOT recur annually like property taxes.

Transfer Taxes and Closing Costs

Transfer Tax / Documentary Stamp Tax

Imposed on the transfer of real property (deed recording)
Charged as a rate per $100 or$ 500 of the sales price
Rates vary dramatically by state and county
Some states charge transfer tax only on the seller; others split between buyer and seller

Transfer Tax Calculation:
Example: Sale Price $350,000; Tax rate $0.70 per $100
Transfer Tax = ($350,000 / $100) × $0.70 = $2,450

Real Estate Taxes: Federal Income Tax Overview

For the salesperson exam, basic awareness of these federal tax concepts is tested:

Capital Gains Exclusion for Primary Residence (§121 Exclusion):

Taxpayer may exclude up to:
$250,000 of gain (single filer)
$500,000 of gain (married filing jointly)

Requirements:
- Owned and used as primary residence for at least 2 of the last 5 years
- May be used once every 2 years

Depreciation (for investment / income property):

Residential rental property: 27.5-year straight-line depreciation
Commercial property: 39-year straight-line depreciation
Land is not depreciable

1031 Exchange (Like-Kind Exchange):

Section 1031 allows deferral of capital gains tax when an investment property
is exchanged for a "like-kind" property:

Key rules:
- Must identify replacement property within 45 days of closing
- Must close on replacement property within 180 days
- Must be investment/business property (not personal residence)
- Exchange must be handled through a Qualified Intermediary (QI)

Key Formula Summary

Coverage Ratio = Building Footprint ÷ Lot Area × 100%
FAR = Total Floor Area ÷ Lot Area

Property Tax = Assessed Value × Tax Rate
Assessed Value = Market Value × Assessment Ratio

§121 Exclusion: $250K / $500K capital gains exclusion on primary home sale
1031 Exchange: 45-day ID window / 180-day close window
Depreciation: Residential 27.5 years / Commercial 39 years

Practice Exam Questions

Q1. What is the maximum legal coverage ratio in an R-2 residential zone, and why does the municipality set this limit?

Coverage ratios vary by ordinance; the purpose is to ensure adequate open space, light, air circulation, and drainage on each lot. High coverage ratios increase impervious surface and reduce property livability.

Q2. When must transfer tax be paid, and who is typically responsible?

Transfer tax is due at closing when the deed is recorded. Most states hold the seller responsible, though this is negotiable in the purchase contract and varies by state.

Q3. Which federal tax provision allows a married couple to exclude $500,000 of gain on the sale of their home?

Section 121 of the Internal Revenue Code. Requirements: owned AND used as a primary residence for at least 2 of the 5 years preceding the sale. Available once every 2 years.

Q4. What distinguishes a special assessment from an annual property tax?

A special assessment is a one-time charge for a specific public improvement that directly benefits the property (e.g., sewer hook-up, sidewalk). Property taxes recur annually and fund general government operations.