Tax time is nearing and once more rumors are circulating on the internet and by e-mail that the health care reform law enacted two years ago includes a 3.8 percent tax on ALL real estate transactions starting in 2013. This is NOT the case. The actual 3.8% tax is on some capital gains and is narrow in scope.Â
Below is an explanation of the scope of this law:
There is aÂ 3.8% Medicare surtax on investment income beginning in 2013 (including capital gains, rents, dividends, etc.). Note that Capital Gains do come from investment sale or transfer of real estate. The Medicaid Surtax is assessed on individuals earning over $200,000 individually or $250,000 as a couple. Thus, since real estate is a capital gains transaction and in the case of a sale of a principal residence for a gain of more than the exclusion amount ($250,000 individually or $500,000 for a married couple) then in addition to capital gains (which is already scheduled to go up next year to 20%) you could possibly have an additional Medicare surtax ofÂ 3.8% on top of that amount. This will only kick in for the income that is above the $200,000/$250,000 modified adjusted gross income. Now, the kicker is that if you are not in a principal residence transaction and capital gains hits you right away (i.e. investment or rental income or a sale of principal residence held for less than 2 years) then if you have capital gains it could likely be hit with theÂ 3.8% Medicare surtax - again ONLY if you are above the $200,000/$250,000 modified adjusted gross income levels.
REAL WORLD EXAMPLES:
Example #1: Meet Bob and Susie, a couple who make $300,000 in income a year. They have a beautiful home that they sell for $2 million, this nets them $750,000 in profit (sale price of the home â€“ commissions and fees â€“ price they paid for the home = profit from the sale of the home). Because they are defined as â€œhigh earnersâ€ (making more than $250,000 a year for a married couple), they will be required to pay the MedicareÂ tax.
Calculating theÂ tax:
profit from the sale â€“ capital gains threshold = taxable investment income
taxable investment income x 0.038 (3.8%) =Â taxÂ due
Using the above formula, Bob and Susie would plug in these values:
profit from the sale: $750,000
capital gains threshold: $500,000 (married-couple filing jointly)
taxable investment income: $750,000 â€“ $500,000 = $250,000
taxÂ due: $250,000 x 0.038 (3.8%) = $9,500
Example 2: Meet Frank and Cindy, a married couple whose combined income totals $200,000. They are selling their home for $400,000. Frank and Cindy are excluded from theÂ 3.8%Â taxÂ because they do not meet the â€œhigh earnerâ€ criteria (income of $250,000 or more).
Example 3: Frank (from Example 2) gets a promotion and begins making $50,000 more a year. This pushes Frank and Cindyâ€™s combined income to $250,000, which now qualifies them as â€œhigh earners.â€ They finally sell their home for $400,000, but after paying their mortgage and the fees associated with a real estate transaction, they take home $50,000 as profit from the sale of their home. They are again excluded from theÂ taxÂ thanks to the capital gains threshold of $500,000 for married couples filing jointly (they would need to take home $500,000 or profit more from the sale of their home to be required to pay the MedicareÂ taxÂ in the health care bill.
Download a free brochure with more information on how the 3.8% tax works at the following link: http://www.realtor.org/small_business_health_coverage.nsf/docfiles/government_affairs_invest_inc_tax_broch.pdf/$FILE/government_affairs_invest_inc_tax_broch.pdf
The aboveÂ article provides general information about tax laws and consequences, but shouldn't be relied upon by readers as tax or legal advice applicable to particular transactions or circumstances. Consult a tax professional for such advice!