3.8% Tax Increase on Real Estate? Here are the Facts...

I have received many calls and emails regarding the new 3.8 percent tax on the net investment income of high-income persons. Very few home sellers will be subject to pay the tax.  Here are the facts regarding the tax:

People 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 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.

There are many questions in regards to this tax.  The provision begins on page 33 of the reconciliation bill that was passed and signed into law.  It does say that the tax is 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. Keep in mind this exclusion does not apply to 2nd homes or rental income properties.  The Joint Committee on Taxation points this out in  a footnote on page 135 of its report on the bill. The note states: "Gross income does not include … excluded gain from the sale of a principal residence."

A few examples of those that would have to pay the tax might include:

A single person making $210,000 a year who sells a $300,000 vacation home for a $50,000 profit. The tax on the sale of that vacation home would amount to $1,900, in addition to the capital gains tax that would need to be paid anyway.

• A couple with combined income of over $250,000 a year sell their $1 million primary residence to downsize to a smaller home.  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.

A typical home sale would not incur any tax.  So for the majority, the 3.8 percent tax won’t apply. The Tax Foundation, a report released April 15, stating 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.

The Internal Revenue Service states to qualify for the $250,000/$500,000 exclusion, a seller must have owned the home and lived there as the seller’s "main home" for at least two years out of the five years prior to the sale.  This has always been true.

As always, contact your accountant for more in depth information regarding the tax and whether or not it will affect you in a home sale situation.  I am not an accountant however hopefully this will clear up any questions that the community has had regarding this tax.