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Real Estate Predictions for 2013

Investment Opportunities Abound

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I've procrastinated as long as possible before finalizing this message. I waited in hopes of news from Washington on a plan to avoid the fiscal cliff and I am certain as soon as I send this newsletter, we will all get that "Breaking News" alert.

Avoiding the Fiscal Cliff

It's likely they will avoid the fiscal cliff but they seem determined to keep us on the edge of our seats until the very last minute. The announcement cannot come soon enough for the many business owners and investors who have postponed countless decisions because of the uncertainty. Both sides of the aisle have now agreed to raise taxes, including capital gains, for higher earning taxpayers but they have not settled on the "magic" number that determines who is a high earner. It could be $1M, $400,000 or somewhere in between. The maximum capital gains tax rate will increase to 20% for those higher earners. Note if we go over the fiscal cliff, the maximum capital gain tax rate will automatically increase to 20% for all taxpayers effective January 1st.

One thing that is certain is the new 3.8% Medicare Tax that kicks in January 1st as part of the new health care reform. We talked about it many times in the last few years but it will apply to single taxpayers with unearned income of $200,000 and married couples over $250,000 (rental income, capital gains, interest and dividends).

Fortunately, 1031 tax-deferred exchanges continue to be a powerful wealth building tax strategy that will allow you to defer the 15 or 20% capital gain as well as the 3.8% Medicare Tax and the 25% depreciation recapture. As always, a 1031 exchange helps investors to grow their portfolios with pre-tax dollars.

New Federal Stimulus

Last week, the Federal Reserve rolled out several new programs to help stimulate the economy. Federal Reserve Chairman, Ben Bernanke, said they plan to keep interest rates near zero until the national unemployment rate drops down to 6.5%. I have several thoughts regarding this:

This will keep mortgage rates at historically low rates and keep many more properties within reach for the foreseeable future.
These low interest rates mean less earnings on cash and other investments but the value of real estate will continue to increase. Real estate remains a safe long-term investment.
The growth factor on exchange funds while held by 1031 CORP. will be minimal. While we try to find well rated banks that provide a competitive rate on our clients' funds, the banks simply are not paying much. Believe it or not, I just spoke with a bank about their rates and was told the higher the balance, the lower the interest rate.

A New Real Estate Boom is Coming

There are a number of reasons to believe there is a real estate comeback in the near future:

One way or another, something will happen with tax rates and once there is some certainty, investors and business owners can begin to make educated decisions and develop or adjust their plans to accomplish their objectives. This will ultimately lead to new jobs, better job security and improved consumer confidence.
Cheap money. Low interest rates enable buyers to stretch their money further. This is good for first time home buyers as well as those looking to trade up and businesses looking to relocate or invest in new equipment.
Property values are starting to rise again. The end to rock bottom prices will force those sitting on the side lines to finally make their move or miss the opportunity.
There is less inventory on the market and the greater demand will drive property values up.
Commercial real estate is wrapping up a great year. Property values are increasing and financing is available.
New housing starts are higher than they have been in years.
We are already starting to see multiple offers on properties and at or above the asking price.

1031 Exchange Volume to Increase Significantly

Qualified Intermediaries (QIs) across the country are reporting a steady increase in business. This is welcome news because nationally 1031 exchange activity was down 80% from 2005 to 2010. Fortunately, the Philadelphia area commercial and residential real estate markets were not as stagnate as many other areas and 1031 CORP. did experience quite a steep decline.

Two years ago, using data from a member survey conducted by the Federation of Exchange Accommodators (FEA), the trade association for QIs, the Joint Committee on Taxation (JCT) estimates 1031 deferrals of $2.5B in next 5 years and $18.2B in next 10 years.

Activity in 2012 increased more than 25% and all indicators mentioned above coupled with increased tax rates will surely lead to a substantial increase in 1031 transactions in the next few years.

Installment Sale Treatment for Failed 1031...Thanks but No Thanks

A 1031 tax-deferred exchange started near the end of a tax year will often run into the following tax year. For those taxpayers who are unable to complete their 1031 exchange, there is always the option to pay the tax in the year in which the exchange was initiated with the sale of the first relinquished property or postpone the tax until the following tax year when the taxpayer actually receives the exchange proceeds from the Qualified Intermediary (QI). For many taxpayers, the postponement of the gain until the following tax year has long been a benefit of a failed exchange. This year, as the reality of higher tax rates in 2013 is setting in, postponing the gain is probably not desirable.

Postponing the Gain until 2013

If you structured your 2012 exchange with a "bona fide intent" to complete the exchange, you may report the exchange as an installment sale on your 2012 tax return because that is the tax year in which the first relinquished property was sold. Under the installment sale reporting rules, the receipt of an indebtedness that is secured directly or indirectly by cash or a cash equivalent is treated as receipt of payment. The regulations state that exchange proceeds held by a QI, such as 1031 CORP., could fall into that category and as long as there is a bona fide intent to exchange, the taxpayer can report cash not reinvested in replacement property as an installment sale. [Reg. 1.1031(k)-1(j)(2); Temp Reg. 15a.453-1(b)(3)(i)]

A taxpayer has "bona fide intent" if it is reasonable to believe, based on all of the facts and circumstances at the beginning of the exchange period, that identified replacement property would be acquired to complete the exchange.

Any cash "boot" received in the following tax year can be reported using the installment sale method. Cash "boot" is any cash not reinvested in replacement property and paid directly to you from the qualified intermediary. This would apply when replacement property is acquired but not all of the exchange proceeds are used or when no replacement property is acquired.

Advantages of Using Installment Treatment...Not so Fast!

Reporting the balance of the exchange funds, also known as cash "boot," using the installment sale method would allow you to defer the gain until the following tax year when you actually receive the exchange proceeds from 1031 CORP. This reporting strategy has enabled those with a failed exchange to postpone the tax at least one tax year and has been very advantageous to investors. However, those considering this strategy for a failed 2012 exchange will have to pay close attention to the capital gain tax rate beginning January 1st and determine if it is better to recognize the gain in 2012 when tax rates will likely be lower.

The regulations do not address how to handle liability relief (the sale proceeds of your relinquished property used to pay off debt against the old property) and whether the gain is due in the year of the sale or in the following tax year provided you had the bona fide intent to complete the exchange. Revenue Ruling 2003-56 related to a partnership whose exchange straddled two tax years and holds that if the exchange straddles two taxable years of the partnership, the amount of the relinquished liability that exceeds the amount of the replacement liability is treated as money or other property received in the first taxable year of the partnership, since the excess is attributable to the transfer of the relinquished property. This reasoning should also apply to other taxpayers.

The installment sale treatment can be very beneficial but taxpayers maybe forced to decide how to proceed without knowing the status of the "Bush Tax Cuts." It is essential that you discuss your situation with your tax advisor to determine what is best for you.

Trending in December...

A Push to Get it Done
While there is traditionally a push to close on properties before the end of the year, we are hearing a significant increase in the "I want to close before the 31st" statements from our clients. There are just as many "the seller needs to close by the 31st." Obviously, the new 3.8% Medicare Tax and the prospect of higher capital gains are motivating people to complete their transactions now and avoid a larger tax bill in 2013.

Message from our President

Dear Friends,

Happy Holidays

from our 1031 CORP. Family to yours!

In the midst of this Holiday Season, it is difficult not to be affected by the tragic events of the past week. I am sure that I am not the only one who hugged their children and loved ones a little tighter recently. It is unfortunate that it takes something so heartbreaking to remind us what is truly important in life. As we are caught up in the mad dash to make the holidays perfect and cramming in every possible activity, I encourage you to take a deep breath and smell the roses. It is easy to be so rushed that we let life just pass by too quickly without living in the moment and enjoying what we have.

From the entire 1031 CORP. family, I wish you and yours a joyous Holiday Season and a happy, healthy and prosperous New Year. We look forward to working with you in 2013!

Best Regards,

3.8% Tax on Capital Gains & Other Unearned Income Starts 1/1/13

Included in The Health Care and Education Reconciliation Act of 2010 signed into law on March 30, 2010 is an "Unearned Income Medicare Contribution" that imposes a 3.8% tax on all unearned income, including any profit on the sale of real estate. It is not a real estate sales tax or national transfer tax. Depending on your income level, the new tax will apply to all unearned income you have regardless of whether or not it is related to real estate.

As part of the new health care reform law, the new Medicare Tax will go into effect on January 1, 2013 and will require high income households to pay 3.8% on all investment income. Generally, this tax will affect individuals with a gross annual income exceeding $200,000 and married couples exceeding $250,000. Some examples of investment income subject to this new tax include capital gains, interest, annuities, royalties and rents.

Increased Medicare Payroll Deduction May be Coming

Also keep in mind that the Medicare deduction from your paycheck may also increase. Currently, the Medicare payroll tax is 2.9% on all wages with you paying half and your employer paying half. Beginning in 2012, high-income individuals will pay another 0.9% for a total of 2.35%.

About 1031 CORP.

Serving as a nationwide qualified intermediary for 1031 tax-deferred exchanges since 1991, 1031 CORP. strives to provide a superior exchange experience for our customers and their advisors. We provide our customers with enhanced security of funds, knowledgeable exchange professionals and a commitment to keep the exchange process simple for our customers and their advisors. Every member of the exchange team is a Certified Exchange Specialist® and has the experience and expertise to facilitate even the most complex exchange transaction, including reverse, improvement and personal property exchanges. Additional information can be found at www.1031CORP.com.

In This Issue

Investment Opportunities Abound

Installment Sale Treatment for Failed 1031 Exchanges

Trending this Month

Message from our President

New 3.8% Medicare Tax Kicks in Jan. 1st

Wealth Building Webinar Series

Article Exchange