This article was posted on Monday, Feb 27, 2012

Setting the Stage

Owners Who Are Selling Their Real Estate Assets Are Doing So For Many Reasons:
1.    Large Class-A properties (“core assets”) are currently achieving high premiums upon sale.
2.    Partnerships are breaking up because investor partners need money.
3.    Many properties bought in the run-up (2005-2008) are not performing so sellers must unload, even if they have to take a loss.
4.    Some sales are caused by divorce.
5.    Some sales are caused by the first of the baby boomers passing away, and their heirs don’t want or know how to take care of the real estate.
6.    Higher demand in some classes of real estate coupled with low interest rates could motivate some sellers to sell.
7.    Existing loan terms are expiring and TIC’s and partnerships need to sell because new, non-recourse loans (such as CMBS) are harder if not impossible to get.

Buyers/Investors Are Buying Because:
1.    They have money and need to invest.
2.    They are looking for properties they can reposition.
3.    The stock market is a rollercoaster; real estate promises some stability.
4.    The strongest asset class across the nation is multifamily, given it is perceived as a less risky investment.
5.    Demographics promise more renters and fewer homeowners mostly as a result of higher down-payment requirements for home buyers.
6.    Banks are willing to lend (but property performance and borrower strength are more important today than in past years).
7.    Low interest rates for short-term loans create opportunity.
8.    The Federal Reserve has promised to keep interest rates low thru early 2013.

Who Are Today’s Investors, And What Are Their Exit Strategies?
There are several consistent patterns when it comes to types of investment strategies.
Typically, investors fall into the following categories:

a.    Buy and hold for 7 – 10 years
b.    Buy and hold for a lifetime
c.    Buy and fix (redevelop) and flip
d.    Develop and flip

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Each one of these investors has three things in common, they want to buy and they will want to sell, and they want to pay the least amount of tax they possibly can.

What Are the Short-Term Tax Implications for 2011 and 2012?
Every investment activity that generates a profit has the potential to create a taxable event. Upon the sale of real estate, the Federal government will want to tax you either as an investor or as a dealer.  As an investor, you pay Federal long-term capital gains taxes, state long-term capital gains taxes, as well as the recapture of 25% of the depreciation you have taken on the asset.  (You can calculate these taxes using a capital gains tax calculator as featured on the Ambar Financial website:

Long Term Gains
The Federal long-term gains tax will be 15% in 2012 and 20% in 2013. The Oregon State long-term capital gains rate is 9%.  In other words, for 2012 your long-term capital tax rate would be 24% plus your 25% depreciation recapture.  In 2013, the long term Capital gains tax jumps to 29%. Action Item:  This means that if you want to sell your real estate and pay the least amount in long term capital gains taxes, you will want to do that before 2013 to save 5% in tax rate.  Action Item:  As a Buyer you need to choose your investments now.
Dealers in real estate (you buy a property and sell in the same year) are faced with   short-term capital gains that are taxed at the investor’s ordinary income tax rate. Depending on income, that Federal rate could be 28, 31, 36, or 39.6 percent versus a 24% capital gains tax rate.
In addition to these taxes in some jurisdictions, such as the State of Washington, you will also pay a transfer or excise tax.

As a real estate investor, what are your choices to maximize your yield, when you sell your real estate?
You have four choices:
1.     Pay long-term Capital gains taxes.
2.    Get taxed as you usually would for ordinary income.
3.    Sell and complete a 1031 tax deferred exchange
4.     Or if you cannot identify a property, rather than pay tax on the boot you can use a structured sale to exit a real estate investment.

Most sellers are very familiar with the 45 day time frame to nominate an investment and the 180 day to close time frames of a 1031 tax deferred exchange.
But many are not familiar with structured sales.  Simply put the money earned upon a sale cannot be touched (much like the 1031), but you can find companies such as “Superior Settlements,” who will take your proceeds and invest them with an insurance company (such as Allstate).  These proceeds then are paid out to you over a period of time that works for you, much like an installment sale.  Like an installment sale, you pay ordinary income taxes on the interest income and long term capital gains on the gain portion of the sale.  Basically using this process the insurance company buys an annuity for you with your money and pays you out over time.
The benefit to this process is that you don’t have to pay all of the taxes at once when you close the sale, and you get your money over a period of time.  The downside to this approach is that in fact you are not moving your basis to the next transaction and deferring your taxes; rather, you are paying your taxes annually as you collect the receipts of your annuity. (You may be faced with a lower yield that the one you were getting from owning the real estate). A good person to call and ask about this is Rick Danowsky of Superior Settlements at 800-358-0312 x 7768.

Given the tax increases scheduled for 2013 and the low interest rates promised for the next two years, we will see more inventory in the market place.  As Sellers start repositioning their portfolios, Buyers will be looking for opportunities that meet their investment criteria.  Many deals will be struck with five year financing Buyers are gambling that the shortage of inventory caused by the lack of construction over the past three years will create shortages of real estate inventory.  This shortage will then translate into higher rents for the next four to five years, which can be used to pay for higher interest rate loans as investors refinance in 60 months.
As an experienced real estate investor, you need to be in the market place and buying now, before the rest of the pack floods the market place.

Clifford A. Hockley is President of Bluestone & Hockley Real Estate Services, greater Portland’s full service real estate brokerage and property management company.  He is a Certified Property Manager and has achieved his Certified Commercial Investment Member designation (CCIM).  Bluestone & Hockley Real Estate Services is an Accredited Management Organization (AMO) by the Institute of Real Estate Management (IREM).

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