Real Estate Blog

Let's talk about taxes. Okay. Let's talk about one tax. The new 3.8% tax on some investment income that will take effect on January 1, 2013. First, let's cut straight to the myth. This tax WILL NOT apply to all real estate transactions. In fact, it's not just a real estate tax, it's a capital gains tax on some investment income.

Who will pay the tax?

- Individuals with an adjusted gross income of more than $200,000.

- Couples who file a joint return with an adjusted gross income of more than $250,000.

What will be taxed? SOME, but NOT all:

- interest

- dividend

- rents (less expenses)

- capital gains (less capital losses.)

And where the heck did this tax originate? That part is interesting, and it's the aspect of the new tax that has contributed to so many false rumors. In the final hours of the debate over health care reform that culminated in the 2010 Patient Protection and Affordable Care Act, Congress couldn't agree on how to get it all paid for -- in particular, the changes to the Medicare program for both individuals and businesses.

The answer was this new real estate tax and the National Association of REALTORS (NAR) didn't like it one little bit. The tax passed anyway, and over the next decade is expected to raise $210 billion or about half the cost of the whole health care reform package. The funds from the tax go straight to the Medicare Trust Fund. The NAR's main objection? That fund is going to go dry anyway and this tax is simply prolonging the life of a very troubled program.

Politics aside, however, what does this new tax mean in practical application? Let's look at a couple of scenarios, remembering that the tax applies to the LESSER of the investment income amount and the excess of AGI over the $200,000 or $250,000 amount.

(Note: All scenarios are taken from the NAR brochure "The 3.8% Tax: Real Estate Scenarios & Examples." For more information visit the NAR page on health care reform and related tax issues.

Scenario 1 - Capital Gains on the Sale of a Principal Residence

A couple sells their principal residence and realizes a $525,000 gain (remembering that they owe no capital gains tax up to $500,000.) They have an Adjusted Gross Income of $325,000 before adding the taxable gain.

Scenario 2 - Rental Income: Income Sources Including Real Estate Investment Income

The owner has a regular job earning $85,000 annually and also owns several small apartments with gross rents of $130,000 and associated expenses.

Scenario 3 - Rental Incomes: Rental Income as Sole Source of Earnings - Real Estate Trade or Business

This owner derives his sole income from owning and operating commercial business, so all these assets are business NOT investment property.

Since this 3.8% tax applies to some investment income, it will effect some real estate transactions in the manner illustrated in these examples although they are far from exhaustive. It is, however, important to remember, that the tax does not take effect until 2013, which gives real estate investors ample time to investigate how and when this tax might come into play with their own investment portfolios. Simply put, there is no need to panic about this tax, just find out how and when it might come into play with your investment goals.