Ever since the adoption of “Obamacare” in 2010, confusion, rumors and disinformation have surrounded what has been referred to as the 3.8% 2013 “real estate tax,” and by others as a “Medicare tax” scheduled to take effect January 1, 2013. Let’s see if we can dispel some of the myths and get down to facts.
3.8% Real Estate Tax, aka “Medicare Tax” Explained:
First, it’s referred by some as a “Medicare Tax” because Congress earmarked proceeds for the Medicare Trust Fund when the legislation was adopted March 23, 2010. It’s estimated that $210 billion will be raised over 10 years with a goal of helping to extend the life of the federal Medicare program.
Rumors persist that the 3.8% real estate tax will apply to all real estate sales. NOT SO, but it can be complex trying to determine if you will have a tax consequence or not. Therefore, it’s important to understand some of the terminology involved before we get down to the numbers.
Net investment income – Income received from investment assets such as bonds, stocks, mutual funds, loans and other investments.
Capital gain – When a capital asset is sold, the difference between the basis in the asset and the amount it is sold for (or a capital loss if it is sold for less).
Basis – the cost of an asset, which includes the purchase price, shopping, installation, and other services associated with the asset.
Adjusted gross income (AGI) – measure of income used to determine how much of your income is taxable and is calculated as your gross income from taxable sources minus allowable deductions, such as unreimbursed business expenses, medical expenses, alimony and deductible retirement plan contributions.
Now, here is just one example of this new tax: Capital Gain on Sale of Principal Residence
o Couple sells house for a realized gain of $600,000
o Adjusted gross income (AGI) is $300,000 (before the sale)
o Taxable gain on sale = $100,000 ($600,000 gain – $500,000 exclusion for married filing jointly on sale of principal residence)
o New AGI= $400,000 ($300,000 + $100,000)
o Excess of AGI over $250,000= $150,000 ($400,000 – $250,000 since married filing jointly)
o Lesser of the excess AGI or taxable gain on sale= $100,000
o Tax due= $3,800 ($100,000 taxable investment income x 3.8% tax)
Note: if the couple had a gain of less than $500,000 on the sale of their residence, none of that gain would be subject to the 3.8% tax. Whether they paid the 3.8% real estate tax would depend on the other components of their $300,000 AGI.
Keep in mind, if all of your income is derived from real estate investments that you own and operate, you may not be subject to the 3.8% tax. Your property may be considered your “trade or business,” and although you are not responsible for the 3.8% tax you could be responsible for a tax on the earned income.
Additionally, if you use rental properties for an investment, then they are not considered a trade or business, no matter the income you bring in. Rental homes that have been rented for more than 14 days could be subject to the new 3.8% tax, assuming that you meet the $200,000/$250,000 AGI threshold.
In the sale of a secondary home there is no tax exclusion for the first $250,000/$500,000 of a capital gain.
Bottom line – The unearned income “Medicare Tax” applies to ALL capital gains, not only home sales. Whatever your income level, or however much you profit from the sale of your investments, everyone’s income and tax situation is different. Our advice is to seek the guidance of your tax professional to see how the 3.8% may, or may not, affect you.
Chris Hounchell & Associates is the leader in general real estate, pre-foreclosure, short sale and foreclosure markets in the Pinellas County area. We are not licensed tax advisors in any capacity, so this information should not be used to make any tax related decision based on the qualification of any information received by Chris Hounchell. For more information on buying vs. renting, contact Chris today at 727-642-9107.