Obamacare and That Scary Real Estate Tax (revisited)
Here we go again.
A client who is interested in selling her property recently told me about a conversation she had with her neighbor. Her neighbor warned that she had better sell by the end of December. “Or what?” I asked? “The hostages die?”
No. Apparently, according to her neighbor, she would owe approximately $5 million in taxes if she closed escrow after the first of the year – because of ObamaCare.
This seems like a good time to dust off an old post on the topic.
Much has admittedly been written about the Affordable Health Care Act or, more specifically, about the part of the Affordable Health Care Act involving a Medicare Tax on certain real estate transactions. And if you are planning to sell your home in 2014, you can probably ignore the warnings to head for the nearest underground bunker.
For those fuzzy on the details, here is a little primer. (Keep in mind that we are talking about primary residences only. For investment properties, it’s a bit more complicated.)
Effective January 1, 2013, there will be a new 3.8% tax assessed when a property is sold.
- The 3.8% tax will only apply to “high income” taxpayers, defined as single filers with an Adjusted Gross Income of more than $200,000 or married couples filing jointly with an Adjusted Gross Income (AGI) of more than $250,000.
- The existing primary home exclusions will remain ($250,000/$500,000 for single and married filing jointly respectively). The new 3.8% tax will apply only to gains that exceed these numbers.
- For the squeakers, those close to the AGI limits, there is this. The tax is NOT imposed on the total AGI, nor is it imposed solely on the investment income. The tax will be determined based on the LESSER of (1) net gain (over the current exclusions) OR (2) the excess of AGI over the $200,000/$250,000 AGI thresholds.
Clear as mud? Let’s try some examples. For ease, let’s assume the taxpayer in our examples is married and filing jointly.
- Your AGI is $5. The gain on the sale of your home is $500,000. No 3.8% tax.
- Your AGI is $5,000,000,000. The gain on the sale of your home is $500,000. No 3.8% tax for you.
- Your AGI is $251,000. The gain on the sale of your home is $600,000, which is $100,000 above the $500,000 exclusion. (Note that I took lots of math in college.) You will be taxed 3.8% of $100,000 (the net gain over the $500,000 exclusion), or $3,800.
- Your AGI is $Warren Buffett. The gain on the sale of your home is $600,000, which is $100,000 above the $500,000 exclusion. You will be taxed 3.8% of $100,000 (the net gain over the $500,000 exclusion), or $3,800. (And, may I suggest, this is the kind of problem you like to have.)
Now, here is where it gets tricky, and this applies to the folks hovering near the AGI limits.
- Your AGI is $5. The gain on the sale of your home is $600,000, which is $100,000 above the $500,000 exclusion. The 3.8% tax will be calculated base on the lesser of the $100,000 gain OR the excess over the AGI limit. In this case, the new AGI is $5 plus $100,000, or $100,005, which is less than the $250,000 limit. Oh, happy day! No 3.8% tax for you.
- Your AGI is $240,000. The gain on the sale of your home is $550,000, which is $50,000 above the $500,000 exclusion. In this case, the new AGI is $240,000 plus $50,000, or $290,000, which makes the excess equal to $40,000. You will be taxed 3.8% of $40,000 (because $40,000 is less than $50,000, duh), or $1,520.
- Your AGI is $0. The gain on the sale of your home is $1,000,000, which is $500,000 above the $500,000 exclusion. In this case, the new AGI is $500,000, which makes the excess equal to $250,000. You will be taxed 3.8% of $250,000, or $9,500.
To summarize, the Medicare tax will apply only to high income earners and only after the current primary home exemptions. And, keep in mind that the gain on your home is calculated by subtracting your cost basis from your sale price. The cost basis is not what you paid for it but the adjusted cost after taking into account the escrow, title, and other real estate fees you paid when you bought and sold, not to mention the cost of the new water heater you had installed in 1993.
There will be a test later.
(As always, remember that, as of this writing, I do not hold a Juris Doctorate degree. Consult your attorney or CPA. Use only as directed. Patent pending. Keep away from children. And so on.)