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Facts and Fiction about the 3.8% 'Real Estate' Tax

Lisa Loper of the Scott Loper Team delves into the realities of the 3.8 percent Medicare tax going into effect January 1, 2013

All kinds of rumors have been swirling about what exactly is the 3.8% tax and how it will affect homeowners. Congress passed this tax in 2010 as part of President Obama’s health insurance and Medicare overhaul and is set to take effect January 1, 2013.  The tax is estimated to bring in $210 billion in revenue over 10 years and is slated to go toward funding the Medicare Trust Fund.

Although referred to as a real estate tax, in reality, it is a tax on “unearned” investment income for high earning taxpayers (individuals who have an Adjusted Gross Income (AGI) over $200,000 and couples filing a joint return with an AGI over $250,000 ($125,000 when filing separately)).  Investment income includes interest, dividends, capital gains (less capital losses), and rental income (less expenses).

Let’s start with what is NOT TRUE about the tax:

  • It is not a “sales tax” on home sales.
  • It is not an increase in the transfer tax on home sales.
  • It does not affect the exemptions already in place on the sale of primary residences when the gains are less than $250,000 for an individual and $500,000 for a married couple.
  • The mortgage interest deduction will not be eliminated for any taxpayers.

What is TRUE about the tax?

  • Your AGI is calculated to include any investment income.
  • The tax applies to the LESSER of the investment income amount or the excess AGI over the $200,000/$250,000 limits.
  • The investment income will be subject to BOTH income tax AND the 3.8 percent Medicare tax.
  • For investors who own rental properties, the tax will apply to net rental income (gross rents minus interest on debt service, repairs, depreciation, and property taxes).
  • The rent from vacation properties that are rented for less than 14 days per year are not considered investment income.  However, when a vacation property is sold, any gain is considered as investment income.
  • If your “sole occupation” is the ownership and management of investment properties, you are not subject to the tax.

How about an example?

A couple has lived in their home for 22 years and sells it for a capital gain of $540,000.  Their earned income is $190,000 per year.  While they would be subject to income tax on their total AGI of $230,000, no tax would be owed due to the 3.8 percent Medicare Tax.

Earned income                                    $190,000

Gain on sale of residence                      $540,000

Total taxable investment income           $40,000 ($540,000 - $500,000)

AGI                                                    $230,000 ($190,000 + $40,000)

AGI threshold for couple                       $250,000 ($230,000 - $250,000 < 0)

3.8 percent Medicare tax owed                       $0

AGI is < $250,000; therefore, no tax is due.

 

If the same couple’s earned income was $300,000, they would owe the 3.8 percent tax on $40,000 which is $1,520 in addition to income tax due on their AGI of $340,000.

Earned income                                    $300,000

Gain on sale of residence                      $540,000

Total taxable investment income           $40,000 ($540,000 - $500,000)

AGI                                                    $340,000 ($300,000 + $40,000)

AGI threshold for couple                       $250,000 ($340,000 - $250,000 = $90,000)

3.8 percent Medicare tax owed                       $1,520 ($40,000 x 3.8 percent)

AGI is $90,000 over the $250,000 limit, but the tax is assessed on only the taxable investment gain of $40,000.

 

One more example:

If an individual has an annual salary of $120,000 but makes $40,000 on net rental income, $10,000 on dividend income, and sold an investment property for net a $60,000 gain, he/she would be subject to the 3.8 percent tax on $30,000 which is $1,140 in addition to the income tax due on their AGI of $230,000.

Earned income                                    $120,000

Net rental income                                $40,000

Dividend income                                  $10,000

Gain on sale of investment property       $60,000

Total taxable investment income           $110,000 ($40,000 + $10,000 + $60,000)

AGI                                                    $230,000 ($120,000 + $110,000)

AGI threshold for individual                   $200,000 ($230,000 - $200,000)

3.8% Medicare tax owed                        $1,140 ($30,000 x 3.8 percent)

AGI is $30,000 over the $200,000 limit for an individual, so the tax is assessed on only the $30,000 not the full investment gain of $110,000.

 

What is also TRUE about this tax?

The tax was never introduced, debated, or reviewed until just prior to passage.

A separate tax (0.9 percent on high earning taxpayers) is also being implemented against “earned” income to also help fund Medicare.

The National Association of Realtors opposes these taxes.

 

The Scott Loper Team includes Scott & Lisa Loper, Keller Williams Real Estate, 601 Bethlehem Pike, Bldg. B, Ste. 100, Montgomeryville, PA 18936, (215) 631-1900, www.ScottLoperTeam.com.

joanne mamrosch October 13, 2012 at 12:15 PM
Thank you for publicizing this article. As a realtor, I have been asked repeatedly about this tax. There was inaccurate information out there,and your presentation has eloquently cleared it up. The issues with Obamacare is that no one really knows what is in the passed bill. Speaker Polosi even made a comment before Congress that the bill should be passed and it could be read later. In reality, that is exactly what they did. Joanne Mamrosch, Associate Broker Keller Williams Real Estate Blue Bell
gerhard sweetman October 13, 2012 at 02:35 PM
Now I know that accouants & lawyers have taken over. Reading ls help also
patrick October 16, 2012 at 12:48 AM
Joanne, you can look it up and read it. It took me about 3 hours to read and another hour to research it.
gerhard sweetman October 18, 2012 at 03:02 PM
"Rule of lawyers" "Foder for lawyers" my quotes your problem
Stephen Eickhoff January 03, 2013 at 05:18 PM
Breathing IS taxed. It's part of the ACA. You may not live without buying health insurance. You pay for insurance, or pay the tax, or go to jail. It's that simple. Thanks, everyone who voted for Obama and his lackeys.

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