“The 3.8% Medicare Tax and How It Could Affect You” by Debbie Waters

Recently, an email showed up in my inbox that had me quite concerned.  Many of you may have received it too.  So, I decided to do a little research and check the facts for myself.  After all, this email pertained to the 3.8% Medicare tax written in the Obamacare bill.  Even more specifically, it directly affects homeowners who sell their homes beginning in January 2013.  What I needed to know were the actual details:  the who, the what, the how much and the when.

I derived my findings and interpretations from Snopes and Politifact.com.  I also checked into realtor.org to get their take on it specifically as it would relate to or affect real estate investors.  You’ll see my point in a minute!

Apparently, this email has been circulating for some time now and causing a lot of confusion as to how the 3.8% Medicare tax directly affects real estate transactions.  The new legislation imposes the tax on profits over the capital gains threshold and is supposed to only apply to individuals making over $200,000 a year or couples filing jointly making $250,000 or more.

The email which I referenced above is incorrect in that it states the tax would be imposed on all real estate sales transactions beginning 2013.  It should also be noted, the tax does not only pertain to home sales, but actually applies to investment income also (income which may or may not derive from the sale of property) AND applies only to people who earn more than the amounts specified in the bill.

The tax also is only applied on real estate transactions that produce profits over a specified dollar amount.

For example:  A couple with an income of $325,000 bought a house for $300,000, sold it 9 years later for $850,000 and produced a $550,000 profit.

A couple can exclude from their gross income profits up to $500,000 from the sale of their principal residence. Thus, the taxable gain from the sale would be $50,000, making the couple’s taxable income $375,000.

The 3.8% Medicare tax would now apply to whichever of the following dollar figures is the lesser:

The amount by which the couple’s taxable income now exceeds the $250,000 income threshold level ($375,000 – $250,000 = $125,000 X 3.8% = $4,750)

OR

The amount of the taxable income gained from the sale of their home ($50,000 was the difference between the $550,000 profit and $500,000 exclusion ($50,000 X 3.8% = $1,900).

Since the second example is the lesser of the two amounts, the couple would pay an additional tax of 3.8% ($1,900).  If the couple had not made more than $500,000 profit, they would not be subject to the additional 3.8% tax.

What concerned me most was that there was no clear explanation as to how real estate investors would be taxed additionally, if at all, at the time of sale of investment properties.  Remember, the bill only allows the “up to $500,000” exclusion on the primary residence.  I was also unclear as to how income from rent would be applied.  So, I checked into realtor.org and got some interesting answers.

If, for instance, you are a full-time investor as your primary source of income, your rents and gains will not be subject to the new tax.  As long as the ownership and operation of your business is your sole occupation, those transactions are exempt.  However, if you have a regular job, and flipping houses is your job on the side, then those transactions are considered investments, thus subjecting you to the tax (of course, as long as you meet the specified requirements).

Also, net rental income is subject to the tax if the rental real estate is part of one’s personal investment portfolio.  Again, this is all subject to adjusted gross income.

Now, you may be wondering why it’s called a “Medicare tax.”  Revenue generated from this tax is supposed to help build up the Medicare Trust Fund that is part of our Social Security System.  The concept of this allocation seems lovely enough, but I’m not going to hold my breath on that one.

Lastly, it’s worthy to note, this bill could seriously have an adverse effect on retirees, in particular. Many times, they’ve been planning their retirement portfolios for many years to ensure their financial futures without causing a burden on adult children, etc.

According to Certified Public Accountant, Bob Keebler, “It’s a tax that punishes people that have been diligent over the years and did the right thing.”  He goes on to say, “Congress has introduced a third dimension-this surtax-that will affect every investment decision and transaction you make.”  This is a strong warning from Keebler, who holds a Master of Science degree in taxation.