Muller: “I wouldn’t be surprised
if the capital-gains rate is 25%
by some point next year.”

(Save the date: RealShare Los Angeles comes to the Hyatt Regency Century Plaza in Los Angeles, CA, on March 27, 2013.)

LOS ANGELES-The expiration date on the current capital-gains tax is but a few weeks away, and there are two important steps investors should take before the rates go up in 2013. According to Tom Muller, co-chair of real estate and land use for law firm Manatt, Phelps & Phelps here, completing sales before year-end and setting up 1031 deferred exchanges are two avenues to consider in order to avoid paying the higher rates.

“It depends on what you think is going to happen next year and in the coming years, but the president has made it clear that he wants a tax-reform bill in place by August 2013, so there is agreement on both sides of the aisle that some kind of reform is needed,” Muller tells GlobeSt.com.

Muller believes there will be some agreement made, and there is an overriding belief that when the smoke has cleared on tax reform, capital-gains rates may be higher than today. “They are currently at 15% now, which is advantageous; it’s as good as it’s ever been under the US tax code.”

Based on this theory, one smart move would be to step up the pace on property sales so that closings occur before year end. “The key is for properties that you anticipate you may want to sell in the next year or so, consider accelerating the sale so that it happens under today’s 15% capital-gains regime rather than the future unknown capital-gains regime,” Muller recommends.

Another route for property holders is to set up 1031 deferred exchanges that position owners not to be subject increased capital-gains rates. “Not that many people know that the IRS has blessed, via a series of rulings, the concept of doing a 1031 exchange even with parties related to the taxpayer trying to unload a property,” Muller explains. “If you have properties with a low basis and you may want to sell them in the foreseeable future, it’s wise to restructure ownership so that in the fullness of time it will allow you to transfer that low basis to a high-basis property you want to keep. This will help you avoid the anticipated high capital-gains tax.”

The 1031 exchange scenario is especially significant for properties that have a low basis compared to their current value, Muller points out. “Perhaps you own a property that you bought a long time ago that has increased in value over the years, or you have depreciated it or done previous 1031s and would recognize a large gain if sold—that’s what you have to worry about. If you bought in 2007 or 2008, this wouldn’t apply.”

Next year’s capital-gains tax rate could be as high as 25%, Muller predicts. “It might be worth the brain damage to do these exchanges since nobody knows what the rate will be. It will need to be a compromise between the president and the House, but I’d be surprised if it’s less than 20% and wouldn’t be surprised it it’s 25% by some point in the next year.”

Interestingly, GlobeSt.com reported in September that while 1031 exchanges and tenant-in-common ownership entities were once popular, now the Delaware Statutory Trust is becoming the vehicle of choice, according to Evan Farahnik, president of ExchangePoint Properties LLC. Before the economic downturn, fractional ownerships usually involved a tenant-in-common structure, whereby under the tax rule up to 35 LLCs could invest in one property and have it be valid for an exchange. Since then, weaknesses in the TIC structure have caused issues for some of the properties that were struggling and for some lenders.