New Real Estate Tax Rumor Explained

Have you gotten emails from friends or family grousing about how there’s a new 3.8% real estate tax that’s going to take money out of your pocket?  Feeling like your already difficult real estate holdings (i.e. your home) are being taxed at a time when you can least afford it?  Want some facts?

Thanks to some great writing by Lew Sichelman, a nationally syndicated columnist, we’ve got a much more understandable take on the tax, its implications, and how it’s really going to affect you.  Below is the article reprinted from MarketWatch in which the currently best known information on this tax is given.

CHICAGO (MarketWatch) — Question: I am one of those anal-retentive people who starts working on his tax returns before the tax year even comes to an end. But forget about 2010. I have heard that there is a new real-estate sales tax for 2011. What do you know about that? —K.J.S., Laurel, Md.

Answer: Not a lot, if only because the tax doesn’t become effective until 2013, which means the Internal Revenue Service is a long, long way from writing the rules.

But I do know that it is not a real-estate tax in the sense that it will apply to all sales. Rather, it is a highly targeted 3.8% tax enacted as part of the controversial health-care reform legislation that has been signed into law and which Republicans are now trying to overturn.

The tax will apply to individuals with adjusted gross incomes above $200,000 and couples filing jointly with more than a $250,000 AGI. If you and your spouse choose to file jointly, the AGI threshold is $125,000 for each of you.

The Medicare tax, so named because the proceeds are to be dedicated to the Medicare Trust Fund, will be on interest dividends, rents less expenses, and capital gains less capital losses. But the key thing to remember is that the tax is based on whichever is less, the gain you made on the sale of the house or the amount your income exceeds the AGI threshold.

It’s complicated, so it’s hard to predict how it will effect every seller. As always with tax matters, it’s best to consult with a professional.

But, courtesy of the National Association of Realtors, here’s a couple of possible — and simplified — scenarios:

— A couple filing jointly with an adjusted gross income of $325,000 realize a gain of $525,000 when they sell their principal residence.

If the gain is less than the $500,000 exclusion on the capital gain ($250,000 for single taxpayers), none of gain would be subject to the Medicare tax. But since the taxable gain is $25,000 above the $500,000 exclusion, it is added to couple’s AGI, bringing it to $350,000.

That’s $100,000 above the $250,000 AGI limit for couples filing jointly. But the $25,000 taxable gain on the sale of the property is the lesser amount in this case, so the extra Medicare tax that would be due Uncle Sam in this case would be $950, or 3.8% of $25,000.

— A part-time landlord earns $85,000 from his day job plus $130,000 in gross rents from several condo apartments that he owns. But he also has $110,000 in expenses related to his income property, including depreciation and debt service, leaving him with $20,000 in net profits from his rental business.

Even though his adjusted gross income is $15,000 above the $200,000 ceiling for individual tax payers, before expenses, he will owe Uncle Sam nothing because investment income is counted as net, not gross, receipts.

— You and your spouse paid $275,000 for a vacation home you have never rented and sell it for $335,000 in a year when your earned income from all other sources is $225,000. Thus, your AGI is $285,000, which is the sum of your $60,000 gain on the sale of the second home and your other income.

Because the $60,000 gain is more than the excess above the AGI threshold of $35,000, you would pay the Medicare tax on the lesser amount. That’s 3.8% of $35,000, or $1,330.

Again, it’s complicated, and it doesn’t start for two more years. Nevertheless, it is worth talking about with your tax adviser.

If you want to talk to a Realtor or tax advisor about this, please give contact me. I’d love to refer you.

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