The effect on real estate of the new 3.8% Medicare tax
What is this transfer tax?
In 2010 Congress passed a new tax to help fund the health care and Medicare overhaul plans. This is a 3.8% transfer tax on the sale of some investment income.
Like most taxes, how it works and who it affects is complex and if you think you are affected you will want to discuss this with your tax adviser. But these are the salient points:
- The tax affects only individuals with adjusted gross income (AGI) above $200,000 and couples with an AGI of over $250,000.
- Some real estate transactions will be affected, but not all.
- Capital gains are affected, so any real estate transaction that does not involve a capital gain will not be taxed.
- The new tax applies to the lesser of either the investment income amount or the excess of AGI over the income levels stated above.
Will I be affected?
The tax seems to most significantly affect sales of investment property of high income individuals and couples, or a second home or principal residence which generated a taxable gain of over $250,000 for a single person or $500,000 for a couple . The National Association of Realtors has prepared a helpful brochure outlining the details of the rules and how it might affect different situations.
The new tax is sometimes called a “Medicare tax” because the proceeds from it are to be dedicated to theMedicare Trust Fund. Th at Fund will run dry in only a few more years, so this tax is a means of extendingits life.
A second new tax, also dedicated to Medicare funding, is imposed on the so-called “earned” income ofhigher income individuals. This earned income tax has a much lower rate of 0.9% (0.009). Like the taxdescribed in this brochure, this additional or alternative tax is based on adjusted gross income thresholdsof $200,000 for an individual and $250,000 on a joint return. Like the 3.8% tax, this 0.9% tax is imposedonly on the excess of earned income above the threshold amounts. An example and some analysis of thistax is presented in Example 5 of this brochure.
Another way of thinking about these new taxes is to think of the 3.8% tax as being imposed on a portionof the money that you make on your money — your capital (sometimes referred to as “unearned income”). The 0.9% tax is imposed on a portion of the money you make on your labor — your salary, wages,commission and similar income related to earning a livelihood.
But who will reallly pay it?
The website FactCheck.Org reports:
The truth is that only a tiny percentage of home sellers will pay the tax. First of all, only those with incomes over $200,000 a year ($250,000 for married couples filing jointly) will be subject to it. And even for those who have such high incomes, the tax still won’t apply to the first $250,000 on profits from the sale of a personal residence — or to the first $500,000 in the case of a married couple selling their home.
We can understand how this misconception got started. The law itself is couched in highly technical language that only a qualified tax expert can fully grasp. (This provision begins on page 33 of the reconciliation bill that was passed and signed into law.) And it does say the tax falls on “net gain … attributable to the disposition of property.” That would include the sale of a home. But the bill also says the tax falls only on that portion of any gain that is “taken into account in computing taxable income” under the existing tax code. And the fact is, the first $250,000 in profit on the sale of a primary residence (or $500,000 in the case of a married couple) is excluded from taxable income already. (That exclusion doesn’t apply to vacation homes or rental properties.) …
So there you have it. The sort of people who would have to pay the tax might include, for example:
- A single executive making $210,000 a year who sells his $300,000 ski condo for a $50,000 profit. His tax on the sale of that vacation home would amount to $1,900, in addition to the capital gains tax he would have paid anyway.
- An “empty nester” couple with combined income of over $250,000 a year who sell their $1 million primary residence to move to smaller quarters. If they cleared $600,000 on the sale, they would be taxed on $100,000 of the profit (the amount over the half-million-dollar exclusion). Their health care tax on the sale would amount to $3,800 over and above the usual capital gains levy.
However, a typical home sale would not incur any tax. In March, for example, half of all existing homes sold for $170,700 or less, according to the National Association of Realtors. Obviously, none of those sales could possibly generate a $250,000 profit, and so none would be subject to the tax.
Thus, for the vast majority, the 3.8 percent tax won’t apply. The Tax Foundation, in a report released April 15, said the new tax on investment income (including real estate) “will hit approximately the top-earning two percent of families” when it takes effect in 2013.
Does it make sense?
Personally, I don’t see how it makes sense to tax home sales to pay for health care. It seems to me that health care should be reworked so that it pays for itself. And it’s unclear yet how this tax will affect the luxury home market where it’s widely assumed that high income homeowners are less affected by a tax burden. But that’s another story for another day!
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