“I can make a firm pledge. Under my plan, no family making less than $250,000 a year will see any form of tax increase. Not your income tax, not your payroll tax, not your capital gains taxes, not any of your taxes.” — President Obama, Sept. 12, 2008
Beginning Jan. 1, 2013, Obamacare imposes a 3.8 percent Medicare tax on unearned income of “high-income” taxpayers. This could apply to proceeds from the sale of single family homes, townhouses, co-ops, condominiums and even rental income, depending on your individual circumstances and any capital gains tax exclusions. Importantly, the “high income” thresholds are not indexed for inflation so the tax will reach increasing numbers of middle-class taxpayers over time.
Here is a summary of the new law obtained from the National Association of Realtors.
• When you add up all of your income from every possible source, and that total is less than $200,000 ($250,000 on a joint tax return) you will NOT be subject to this tax.
• The 3.8 percent tax will NEVER be collected as a transfer tax on real estate of any type, so you’ll NEVER pay this tax at the time that you purchase a home or other investment property.
• You’ll NEVER pay this tax at settlement when you sell your home or investment property. Any capital gain you realize at settlement is just one component of that year’s gross income.
• If you sell your principal residence, you will still receive the full benefit of the $250,000 (single tax return)/$500,000 (married filing joint tax return) exclusion on the sale of that home. If your capital gain is greater than these amounts you will include any gain above these amounts as income on your Form 1040 tax return. Even then, if your total income (including this taxable portion of gain on your residence) is less than the $200,000/$250,000 amounts, you will NOT pay this tax. If your total income is more than these amounts a formula will protect some portion of your investment.
• The tax applies to other types of investment income, not just real estate. If your income is more than the $200,000/$250,000 amount, then the tax formula will be applied to capital gains, interest income, dividend income and net rents (i.e., rents after expenses).
• The tax goes into effect in 2013. If you have investment income in 2013, you won’t pay the 3.8 percent tax until you file your 2013 Form 1040 tax return in 2014. The 3.8 percent tax for any later year will be paid in the following calendar year when the tax returns are filed.
• In any particular year, if you have NO income from capital gains, rents, interest or dividends, you’ll NEVER pay this tax, even if you have millions of dollars of other types of income.
• The formula that determines the amount of 3.8 percent tax due will ALWAYS protect $200,000 ($250,000 on a joint return) of your income from any burden of the 3.8 percent tax. For example, if you are single and have a total of $201,000 income, the 3.8% tax would NEVER be imposed on more than $1,000.
• It’s true that investment income from rents on an investment property could be subject to the 3.8 percent tax. BUT: The only rental income that would be included in your gross income and therefore possibly subject to the tax is net rental income: gross rents minus expenses like depreciation, interest, property tax, maintenance and utilities.
The tax was enacted along with the health care legislation in 2010. It was added to the package just hours before the final vote and without review. The National Association of Realtors, strongly opposed the tax at the time and remains hopeful that it will not go into effect.
Realtors in their explanation of the Obama tax frequently use the words “Always” and “Never” in describing the law’s impact on real estate. Words that convey absolutes should never be used to describe tax rates. The first statewide sales tax in California was adopted back in 1933. The rate was 2.5 percent and had an expiration date of 1935. You can bet that lawmaker likely told their constituents back then that the tax would “Never” exceed 2.5 percent and that the money would “Always” be used for essential programs like education.
Ken Calhoon is a real estate broker in El Dorado County. He can be reached through his website at kencalhoon.com.