If you’re like most long-term commercial real estate investors, you’re holding your properties to avoid paying the capital gains tax. I don’t blame you. Who likes paying taxes, anyway?
But if you’re like most long-term commercial real estate investors, you’re also faced with a dilemma. You’re thinking of selling, but don’t want to 1031 exchange into another property and you don’t want to pay those taxes.
Should you pay your taxes or take your chances?
There are a few tricks you can use: estate planning, charitable remainder trusts, 1031 exchanges, installment sales, etc. But what if none of these tactics suit your goals of selling your property, liquidating your equity, and moving on from commercial real estate ownership?
Bad news. You may have to pay your taxes.
The Bush Tax Cuts provided us with a 15% Federal capital gains rate, which is one of the lowest rates since 1987. This rate is was extended under the Obama administration through the end of 2012 and after that, all bets are off.
With the spending out of control in Washington D.C., repaying the debt must come from us, and a larger slice of your profits and depreciation will be one of the places the government targets.
The 2012 deadline means that you and I have no idea what the new capital gains rates will be.
Simply, let’s say the capital gains rate increases by 10% to 25%, returning to 1996 levels. A commercial property investor with $3,000,000 in profits would owe an additional $300,000 in capital gains taxes. This amount may be survivable, but here’s the sticky part.
The investor who buys your investment property plans for a 25% capital gains rate when he sells. If he’s planning to improve the commercial real estate by adding value, he’s selling the building for a profit in the future. And when he calculates his profits, he allocates a portion of his proceeds to Uncle Sam, which means he’ll offer you less for your property.
Now your $3,000,000 in profits equates to $2,500,000 as your buyer reformulates your market value. You’re down $500,000, plus your additional $250,000 in new capital gains taxes, which amounts to a $750,000 difference in your checking account.
Many owners I speak with tell me that they don’t want to sell their commercial real estate because of the tax liability. Who wants to sell a property and send 22.5% to the federal government?
I believe, however, that by the end of 2012, 22.5% might seem like a bargain.
It’s up to you.
Is it better to get out now and pay your taxes, or wait to see what happens in Washington, D.C? Please comment below.
About the Author: Jeremy Cyrier, CCIM is the President of MANSARD, a market research driven commercial real estate brokerage and advisory firm, and member of the CCIM Institute faculty. You may reach Jeremy at Jeremy@Mansardcre.com.
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