The 2013 Medicare Tax and the implications for real estate
By Oliver Frascona, Frascona, Joiner, Goodman and Greenstein, P.C., and Leonard R. Johnson, Johnson Kightlinger & Company
There have been many questions and rumors about the new "tax on real estate." It appears there are some inaccuracies and over exaggeration and the record needs to be set straight.
Congress passed a bill called the Patient Protection Affordable Care Act ("PPACA"), sometimes referred to as "Obamacare." The act takes effect in January 2013. There is a Medicare tax associated with this act, which will affect some real estate transactions. Some people have mistakenly referred to this as a sales tax on the sale of a home. This is not exactly accurate, though under certain situations the effect is the same.
This new Medicare tax is an additional tax of 3.8 percent on "Net Investment Income," which is defined rather broadly but does include the sale of a residence. While the tax is imposed on the gain from selling one's home; it is only calculated on the amount after the exemption currently in place, which is $250,000 for a single taxpayer and $500,000 for a couple filing jointly.
Net Investment Income for purposes of the new 3.8 percent Medicare tax includes interest, dividends, annuities, royalties and rents and other gross income attributable to a passive activity. Gains from the sale of property that is not used in an active business (such as investment property or your home) and income from the investment of working capital are treated as investment income as well. However, the tax does not apply to nontaxable income, such as tax-exempt interest or veterans' benefits. Further, an individual's capital gains income will be subject to the tax and as stated above this includes gain from the sale of a principal residence above the current exemption amount and the sale of a vacation home.
Here's how that works:
Mr. and Mrs. Robinson purchased a home for $500,000 and sold it five years later for $800,000. Since they are a couple filing jointly, they are exempt from tax on the first $500,000 of profit. Thus they are not subject to taxable gain on their tax return.
Mr. and Mrs. Jones purchased a home for $250,000 and sold it in five years for $950,000. Thus, the gain realized is $700,000. They are exempt from tax for the first $500,000. However, the excess $200,000 is subject to capital gains tax. This tax for federal, state and local is approximately 20 percent. If this transaction occurred in 2013, the taxpayer would also be subject to an additional Medicare tax of 3.8 percent on the $200,000 profit. Thus, the tax they would have to pay would be increased from $40,000 to $47,600. It is important to note that the Medicare Tax can be an adjustment reducing profit prior to computing capital gains tax.
So, you see that the Medicare Tax is not really a real estate tax, but it is merely a tax on the gain a seller realizes that is over and above the amount that is covered by the existing profit exemption of $250,000 (single) or $500,000 (married couple).
Contact the office of Oliver Frascona if you would like to discuss the tax consequences of the new 3.8 percent Medicare tax on investment income.