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VOL. 128 | NO. 34 | Tuesday, February 19, 2013

Capital Gains Tax Could Hurt Local Real Estate

By Sarah Baker

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When investor/developer Phil Woodard sells his warehouse at 138 St. Paul Ave. in the South Main Historic Arts District to nonprofit ArtSpace this year for $850,000, he’ll be handing over $3,500 from his proceeds to the federal government.

That’s because as of Jan. 1, many investors below the top tax bracket owe an additional 3.8 percent Medicare surtax on passive investment income from interest, dividends, rents and capital gains. The tax falls on individuals with an adjusted gross income above $200,000 and couples filing a joint return with more than $250,000.

Woodard bought the Class A warehouse for $600,000 in 1999. Its 2012 county appraisal was $436,800.

“If you sell something now, it’s going to take a pinch,” Woodard said. “The way the economy’s going now – the real estate was just kicking in, people were starting to buy. The low-end and the high-end stuff was actually selling.

“Is this going to change it? Do we add money to every condo we sell over $250,000? We have to be careful.”

The 3.8 percent tax comes after the top capital gain tax rate was permanently increased from 15 percent to 20 percent under the American Taxpayer Relief Act of 2012. It results in an overall 23.8 percent rate for higher-income taxpayers – a 58 percent increase from 2012 tax rates, according to the Qualified Intermediary firm Asset Preservation Inc.

“It’s definitely a pretty good dent,” said Preston Thomas of Colliers International. “You can sometimes have a gain in a property without making money on it that you have to pay tax on depending on what your basis is in it.”

Thomas said the 3.8 percent on smaller transactions wouldn’t be a big deal. But as larger transactions come around, it’s a substantial cost to the seller, which in turn is a cost to the buyer.

“The seller’s got to make up for it somewhere, so they’re going to try to get a higher price for the real estate,” Thomas said. “I don’t think it’ll help (the market). It just kind of is what it is. Depending on if we’re representing sellers or buyers, it’s something that needs to be addressed on the front end so everybody’s aware of it. It is definitely very relevant.”

Johnny Lamberson of CB Richard Ellis Memphis’ investment sales division said he hasn’t heard sellers suggest that they’re not going to sell because of capital gains yet, but it’s still early in the year.

While no one wants to pay more taxes, he expects the new tax to affect the types of purchasing entities involved in a particular deal differently.

“A lot of these folks quite honestly, especially the big boys, when they sell something they’re going to go into a 1031 Exchange anyway, so they’re not going to pay that tax,” Lamberson said. “Whereas if it’s a private syndication or a partnership where this may be their only deal with no plans of any future deals, then they’re the ones that are going to be affected by that.”

Also known as a tax deferred exchange, a 1031 exchange can take place if an entity sells an office building, for example, and that entity is allowed in a certain timeframe to go buy another office building and use the first sale’s proceeds to buy it. The seller then postpones paying the tax.

Mark Halperin of Boyle Investment Co. agrees with the idea that it might influence the larger institutional type seller less than it might affect the smaller, individually owned seller. But he said the tax is not going to affect Memphis any differently than it would affect St. Louis or Phoenix.

What hurts Memphis more, Halperin said, is the city’s real estate taxes on commercial property. An office building here can have double the taxes of a comparable property in Nashville.

Boyle, a development company that buys far more often than sells, hasn’t yet felt the sting of this year’s adjustments to capital gains. In the event that the firm does sell, Halperin said they’d try to raise the price to compensate – if the market allowed it.

“The market determines the price, not the taxes,” Halperin said. “It’s going to be less net revenue for the seller. For some people, they may be reluctant to sell. As taxes get higher, it can impede the velocity of sales, depending on the individual circumstances of the seller.”

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