Next year could bring some significant tax increases, and now is the time to start planning.
On a recent episode of my “America’s Commercial Real Estate Show,” I talked with a panel of experts about tax strategies and took an in-depth look at the potential tax changes that lie ahead in 2013. My guests shared their insights and tips to help real estate investors protect their interests and minimize their tax burden.
Experts say 2013 is a minefield of potential new taxes. All eyes are watching Washington for possible tax increases — from capital gains to carried interest.
“The great mystery is, ‘What will tax rates be in 2013?’” said Linda Goold, director of federal taxation at the National Association of Realtors.
Of course, one of the hottest topics is the capital gains tax.
Remember when Congress passed that last-minutein 2010 to extend the Bush-era tax cuts for two more years? Well, it’s set to expire again at the end of the year.
If Congress does not act by year end, the capital gains rate will go from its current level of 15 percent to 20 percent.
“We don’t have a prediction right now on what Congress is actually going to do, but I think we should prepare for the possibility of a 20 percent rate come January,” Goold noted.
Another tax break that ends in 2013 is bonus depreciation, explains Anita Anand, a senior associate at the Reznick Group.
Last year, tax payers were able depreciate 100 percent of their assets in one year and this year, they were able to depreciate 50 percent and take the remaining 50 percent over the depreciable lives of their properties. But in 2013, the law reverts back to traditional depreciation methods, Anand said.
Still More New Taxes
There is an important new tax you need to worry about for next year. Beginning Jan. 1, 2013, a 3.8 percent tax on some investment income will take effect for individuals with an adjusted gross incomes above $200,000 and couples making more than $250,000.
You can thank “Obamacare” for this one. This new tax was passed by Congress in 2010 to help generate an estimated $210 billion to help fund President Obama’s healthcare reform and the Medicare overhaul.
Unfortunately, the formula by which the tax is calculated makes it difficult for real estate investors to determine whether they will be affected, Goold said.
Goold didn’t mince words about this new tax, which appeared at the last minute during negotiations over health-care legislation. She fondly refers to it as “an abomination.”
Industry insiders are also watching closely to see if Congress might try to impose tax hikes on carried interest. Carried interest has historically been treated as capital gains, but the U.S. House of Representatives has passed legislation four times that would instead tax carried interest at an ordinary income rate.
Carried interest legislation has never passed the U.S. Senate, but it is still a concern — especially if there is a Democratic sweep of the White House and Congress in the upcoming election, Goold reports.
“This is one provision that is very dependent on how the election comes out,” said Goold.
With the possible capital gains tax increase and the new 3.8 percent tax on investment income, experts are bracing for a bigger tax burden overall.
“You’ve got your federal capital gains rate, most states also have an effective tax rate and now you’ve got this additional increase of 8.8 percent,” said Ricky Novak, CEO of Strategic 1031 Exchange Advisors. “Essentially, you are looking at almost a 10 percent increase on the sale of an asset.”
Ready, Set, Sell?
With these taxes on the horizon as 2012 draws to a close, it’s time to assess your situation and focus on last-minute tax strategies.
This means it could be time to sell certain properties. For example, if you own a property with a lot of gain, you may want to try to sell it and close before year-end to avoid paying higher taxes in the future.
“If you’re an investor who potentially needs some liquidity, and you’re thinking about selling in the next 12 months, then it would be foolish to not sell before the year end because of the various tax increases,” said Novak.
Novak also expects to see a lot more interest in 1031 exchanges as the new year approaches.
“If you are increasing the effective tax on your gains by 8.8 percent, that is going to have a significant impact on your bottom line, so we do expect that we will see a greater volume of clients choosing to do exchanges versus just selling and cashing out,” Novak explained.
The time is right to think about federal and state tax credits, some of which can be purchased up until April for the preceding tax year.
“From a pricing perspective — depending on whether it’s a federal or state-based program — tax payers can save anywhere from 10 to 20 percent through leveraging some of those tax credits,” Novak said.
If you have bad debt, consider taking a federal bad debt deduction this year to get some tax benefit, said Anand.
It’s also the time of year to make last-minute charitable contributions. And don’t limit yourself to cash donations.
“Consider donating appreciated stock — stock that has been held for over a year — because you’re going to get the fair market value of the deduction, so you are getting full value from the tax perspective and then you are also going to be avoiding including the gain on that stock later on,” said Anand.
Michael Bull, CCIM, is the president and founder of Bull Realty, a regional commercial real estate firm based in Atlanta, and the host of the weekly radio show “America’s Commercial Real Estate Show.”