As most of our readers are probably aware, there will be a new 3.8 percent tax on specific real estate transactions beginning January 1, 2013, which is intended to partially fund the Health Care and Medicare overhaul. The legislation was passed by Congress in 2010 in order to produce approximately $210 billion over 10 years, which is more than half of the new law's total expenditures. The new tax is often referred to as the “Medicare tax” due to the proceeds being earmarked for the Medicare Trust Fund.  There has been much information circulating about who will be affected by this tax and even those of us in the real estate industry have needed to wade through erroneous materials and miscommunications in order to ascertain what is factual. 

Fortunately, the National Association of Realtors® (NAR) developed a very concise brochure about the implications titled “The 3.8% Tax - Real Estate Scenarios & Examples”.   Please keep in mind, it is a complex tax and every real estate transaction must be considered on a case-by-case basis as it will most certainly NOT affect all sales. The entire NAR article can be viewed at www.eralandmark.com/tax.
 
The first important criterion is that the tax will affect individuals with adjusted gross income (AGI) of $200,000 and above or couples who file a joint return with an AGI of $250,000 and up. The second factor is that the types of income involved are interest, dividends, rents (less expenses), and capital gains (less capital losses). The complicated formula is that the newly created tax will apply to the lesser of the investment income amount or the excess of AGI over the $200,000/ $250,000 value.
 
Below is an example from NAR’s brochure which corresponds to one of the most common scenarios for this tax, the sale of a primary residence where a capital gain is realized. As in the past, that gain can be excluded from your taxable income for up to $250,000 for an individual and $500,000 for a married couple so long as the home has been owned and lived in as a primary residence for two years.
 
Capital Gain: Sale of a Principal Residence
John and Mary sold their principal residence and realized a gain of $525,000. They have a $325,000 Adjusted Gross Income (before adding taxable gain).
 
The tax applies as follows:
AGI Before Taxable Gain                      $325,000
Gain on Sale of Residence                     $525,000
Taxable Gain (Added to AGI)                $25,000 ($525,000-$500,000)
New AGI                                              $350,000 ($325,000+$25,000 taxable gain)
Excess of AGI over $250,000               $100,000 ($350,000-$250,000)
Lesser Amount (Taxable)                        $25,000 (Taxable gain)
Tax Due                                                       $950 ($25,000 x 0.038)
 
NOTE: If John and Mary had a gain of less than $500,000 on the sale of their residence, none of that gain would be subject to the 3.8% tax. Whether they paid the 3.8% tax would depend on the other components of their $325,000 AGI.
This is just one illustration, and differences exist when dealing with rental income (both as an investment and a sole source of earnings) or the sale of second homes, inherited real estate, and investment properties. Furthermore, there is a second new tax that is being levied on “earned income”. It has a lower rate of 0.9% yet is based on the same earning levels. The main difference is that it is based on the money you actually earn (salary, wages, etc.) versus the money you make on your money (“unearned income”). 

Though this is just the briefest of overviews, the main take-home point is that these new provisions impose the tax on SOME high-income households who experience a capital gain on the sale of real property. If you think you may fall into this category and are looking to sell your property, now is the time to consult your accountant and real estate agent and potentially close the sale by the end of this calendar year.