REAL ESTATE TAX OR MEDICARE TAX?
There has been a lot of misinformation thrown around about the 3.8% Tax on Real Estate starting in 2013. For example, I have seen blogs and comments where people are proclaiming that anyone who sells their home will be subject to this tax and that the tax applies to the entire sale price of the home. I have also heard some people who think this tax applies to the purchase of real estate. Neither of these statements is true.
This 3.8% tax is part of the Patient Protection Affordable Care Act, or Obamacare, as it is known, and will help to fund Medicare. Essentially, it is a Medicare Tax on investment income. The tax applies to all sorts of investment income, but this article will focus only upon real estate sales income. It is important to note that the tax applies to a certain portion of the gain from the sale of real property or upon a taxpayer’s total modified adjusted gross income (MAGI). It is not a tax based upon the sale price of real property. And it is not a tax paid by buyers of real estate.
HOW IT WORKS AS TO REAL ESTATE SALES
The 3.8% real estate tax can apply to both the sale of an investment property and the sale of a primary residence, depending upon the circumstances. This tax will NOT typically affect most middle and lower income people in the US, particularly in the case of the sale of owner-occupied “primary residence” real estate. However, this tax could disproportionately affect residents of Oahu and other expensive locations because real estate is expensive here and has appreciated greatly over the past 20 years, and because many people here earn a high income, corresponding to the high cost of living. This tax will certainly affect many owners of Oahu investment properties who wish to sell in 2013.
The 3.8% real estate tax applies to the LESSER of either: (1) the difference between the taxpayer’s total modified adjusted gross income (MAGI) and (a) $200K, if single; (b) $250K, if married, filing jointly or (c) $125K, if married, filing separately; OR (2) the actual taxable gain on the sale of Oahu real property (Oahu investment property or Oahu primary residence).
NOTE: This 3.8% tax on Oahu real estate sales does not negate the exclusions from capital gain of $250K for a single person and $500K for a married couple on the sale of a primary residence
EXAMPLES
How this tax works with the sale of an Oahu primary residence:
Sally is single resident of Oahu and has a MAGI of $250K.
Sally sells her Oahu home (which is her primary residence) for $1 Million. She purchased the home 12 years ago for $600K, but her adjusted basis is $725K. She, therefore, has a gain of $275K ($1M-$725K).
Because of the $250K primary residence capital gain exclusion, Sally’s taxable gain on her Oahu residence is $25K ($275K gain minus $250K exclusion). This $25K taxable gain is added to Sally’s MAGI of $250K and her total equals $275K.
- Sally’s excess MAGI over $200K (the number after which the 3.8% tax applies for singles) is $75K. ($275K MAGI - $200K =$75K)
- The excess taxable gain (after the $250K exclusion) on her primary residence is $25K.
You take the LESSER of the two, so the 3.8 percent Medicare tax is applied only to the excess $25K gain. As a result, Sally owes an additional $950 in tax on her $1 Million Dollar sale or real estate.
Here is how this works with an Oahu investment property:
Steve is a single resident of California and has MAGI of $175K.
Steve sells his second home on Oahu, a condo in Waikiki for which the adjusted basis was $200K and he sold for $300K, leaving a gain of $100,000. His taxable gain is $100K since there is no primary residence capital gains exclusion on his second home on Oahu. This amount ($100K) is added to his MAGI of $175K to equal a total of $275K.
- Steve’s excess MAGI over the $200K is $75K.
- Steve’s Oahu second home sale taxable gain is $100K.
The tax is applied on the LESSER of either the MAGI over $200K or the taxable gain. Therefore, the tax is on the excess MAGI because $75K is less than $100K
The 3.8 percent Medicare tax is applied to the $75,000 in excess income, so Steve owes an additional $2,850 in taxes for the sale of his investment property.
These are simplistic examples for what is actually a pretty complex law. And you should note that the tax does not apply only to the sales of real estate, so please check with you accountant to the law’s exact application to your circumstances.
Please note: This blog post is for basic informational purposes only and is not to be contrued as tax or legal advice. Please consult with your accountant, attorney and other experts to see how this law applies to you. Every situation is different, involves various unknown factors, and may have a different outcome than the examples provided here.