You may have heard rumors that the Patient Protection and Affordable Care Act (often referred to as Obamacare) imposes a 3.8% transfer tax on all real estate sales and may be concerned that you will incur the 3.8% tax if you sell your home.
The origin of this rumor is the 3.8% tax on some investment income that was added to the legislation at the last minute to help shore up Medicare. Beginning on January 1, 2013, the new tax will apply to certain investment income, e.g. capital gains, dividends, interest payments, and net rental income, received by individuals with adjusted gross income of more than $200,000 and married couples with adjusted gross income of more than $250,000. All of the revenue derived from this new tax will be paid into the Medicare Trust Fund.
In examining the application of this tax to real estate sales, it is important to note that $250,000, in the case of individuals, and $500,000, in the case of married couples, of gain from the sale of a principle residence remains excluded from taxation under the federal income tax law and is excluded from the new 3.8% Medicare tax as well.
If you file your federal income tax return single, the tax will only apply with respect to the sale of your principal residence if both (a) you sell your home for at least $250,000 more than you paid for it (i.e., you have more than $250,000 of gain on the sale of your home), and (b) your adjusted gross income is more than $200,000. If you and your spouse file a joint federal income tax return, the tax will only affect you if (a) you have more than $500,000 of gain on the sale of your home, and (b) your combined adjusted gross income is more than $250,000. (If you are able to sell your house in this market for $500,000 or more than you paid for it, please call me and let me know your secret.) Even then, only that portion of your gain that exceeds the excluded amount of gain will be subject to the tax.
For example, let’s say you and your spouse bought your home for $1,000,000 and sell it for $1,525,000 (after the expenses of the sale) for a $525,000 gain. The maximum amount of gain that could be subject to the 3.8% Medicare tax would be $25,000, the amount by which the total gain exceeds the $500,000 exclusion. In this case the maximum amount of the Medicare tax would be $950. The final determination of the amount of the tax would also take into account the amount and type of additional income that is includable in your adjusted gross income.
Of course, you need to consult your accountant or tax advisor concerning the tax consequences of your real estate dealing. It is clear, however, that the 3.8% tax is not a general transfer tax on real estate. Although the tax may apply to gain on some real estate investment transactions, in today’s real estate market it will apply only to a small portion of the gain on a limited number of sales of principal residences.
The NATIONAL ASSOCIATION OF REALTORS has prepared a brochure that explains how the 3.8% Medicare tax applies to a variety of situations, both those involving gains from real estate sales and those involving gains from other types of investments. If you call or email me I will be happy to email that brochure to you.