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There is rust right above the gas flame in our water heater (not outside the water heater as in this question Rust spots on water heater -- time to replace? or on the inside where the sacrificial anode might be an issue). A repair guy said this indicates a slow leak that could become a big problem all of a sudden, and that we should probably replace the water heater. The water heater is an American Water HEater Proline model and it is about 12 years old. Should we replace it?

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I've never seen a burner assembly area that wasn't rusty, H2O is a byproduct of combustion. Things to consider: is the exhaust vent in good condition, is the TPR valve not leaking and in working order? Provided it's not in a location where a catastrophic leak would cause damage, ride it out. That being said, 12 years is getting towards the end of its life. If, at some point in the next few years, a few days without hot water is unacceptable, replace it soon or begin saving money now by upgrading to a tank-less.

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    ... or upgrading to an indirect-heated tank, which is the solution I took since I had already invested in a high-efficiency boiler. – keshlam Nov 3 '14 at 21:46

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