01/27/2011

You gotta love the Internet. Information (and dis-information) on steroids coming at us 24/7. I started getting emails from clients in the fall with forwarded messages of doom, that ObamaCare promised to tax one of our nation’s most sacred tax “loopholes” – the gain on the sale of our principal residences – in order to pay for the escalating costs of Medicare. If you sold your house for $200,000, one of these propaganda pieces proclaimed, you will pay a 15% capital gains tax of (GASP) $30,000!! NO NO NO, I told one and all. And assured them that whoever was spamming the country with this nonsense must have some agenda. Might I guess — fear, in an election year? Neither side of the aisle is innocent in playing with our collective phobias. So – it is important to shed light on what is true and what isn’t on this issue.

There is no group more impacted by the real estate taxation disinformation campaign than the National Association of Realtors. If you think you are going to be taxed into infinity on the sale of your home, well—maybe you just won’t sell. And then realtors may have to tighten their belts. As a result, the National Association of Realtors published an excellent brochure that provides examples and plain language explanations of how the health care law MIGHT effect you when it comes to sale of real estate.   You can look it up yourself at http://speakingofrealestate.blogs.realtor.org/2010/11/24/the-3-8-tax-is-not-a-real-estate-transfer-tax/.

Here is the skinny: Beginning in January 2013, there will indeed be a new 3.8% tax on SOME (not all) investment income for SOME (very few) taxpayers. It is, of course, complicated. The law MAY impose a 3.8% tax on SOME income from interest, dividends, net rents and net capital gains and MAY impact individuals with adjusted gross income (AGI)exceeding $200,000 and couples with adjusted gross income (AGI) exceeding $250,000. It will apply to the LESSER of the investment income amount OR the excess of of AGI over the $200K or $250K limits. All those “somes,” “mays,” and “lesser” are limiters.

Important to note: nowhere in the new legislation do we Americans lose our $250,000 (for singles) or $500,000 (for couples) capital gain exemption on the sale of our principal residences. Nowhere. Congress people, Internet bloggers, news media, your father – anyone who tells you that everyone will be taxed on personal residence sale has either not read/understood the new law OR they are willfully sharing disinformation with you. Or __________ (you fill in the blank).

 
That said, the tax is real. It will be more real for some taxpayers than others – generally if your income is higher than $200-$250K you will have to think about it and even perhaps plan with it in mind.

Here is an example from the brochure mentioned above showing that SOME people will have a tax:

John and Mary sell their primary home (tax lingo: principal residence) and realize a GAIN of $525,000. A miracle in today’s market, to be sure. Remember that a GAIN means that they purchased their home for, let’s say, $250,000 and they are selling it for $775,000 ($775 – $250 = gain of $525). They are STILL ALLOWED AN EXEMPTION of $500,000 – the new law did NOT take this benefit away from us!!  But their gain was greater than $500K by $25K…so they have a “taxable gain” of $25K. This couple’s AGI before the gain was $325,000. So now we add the $25K to the $325K and come up with new AGI of $350K. Here is where the new 3.8% tax comes into play. We apply it to the LESSER of the investment income ($25K) OR the excess of AGI over $250K ($350K AGI – $250K limiter = $100K). The LESSER is $25K. The tax rate of 3.8% is multiplied by the $25K = $950.

Another example:

Harry and Sarah have substantial income from their securities investments. Their AGI before considering the investment income is $190,000. They also have $60,000 in interest income from bonds and CDs, dividend income of $75,000 and capital gains from the sale of stock of $10,000. Their investment income totals $145,000, which gets added to the $190,000 of other income to equal AGI of $335,000. Here is the tax again – we apply it to the LESSER of the investment income of $145,000 OR the excess of AGI over $250K ($335K AGI – $250K limiter = $85K). The LESSER is $85K. The tax rate of 3.8% is multiplied by the $85K = $3,250. That is starting to sound like real money. But keep in mind the income limits.

So – bottom line: YES – there is a 3.8% tax imposed on SOME higher income taxpayers on investment income. NO – you will probably not be taxed on the sale of your personal residence unless you are fortunate enough to have made a substantial capital gain on the sale and you earn more than $200K/$250K otherwise.

The goal of the new tax is to shore up Medicare. Supporters say it will raise $210B for the beleaguered Medicare system. Hard to tell. Remember – if the health care act is not repealed, this tax will become effective in 2013.  I would LOVE it if ALL of our clients had to worry about this tax by 2013.  Think about that. 🙂