When the Supreme Court upheld the health-care reform law on federal tax grounds, it restoked a housing issue that had been relatively quiet for the past year: The alleged 3.8 percent real estate tax on home sales beginning in 2013 that is buried away in the legislation.
Immediately following enactment of the health-care law, waves of e-mails hit the Internet with ominous messages aimed at homeowners. A sample: “Did you know that if you sell your house after 2012 you will pay a 3.8 percent sales tax on it? When did this happen? It’s in the health care bill. Just thought you should know.”
Once litigation challenging the law’s constitutionality surfaced in federal courts, the e-mail warnings subsided. But with the law scheduled to take effect less than six months from now, questions are being raised again: Is there really a 3.8 percent transfer tax on real estate coming in 2013? Does it preempt the existing $250,000 and $500,000 capital gains exclusions for single-filing and joint-filing home sellers as some e-mails have claimed?
Here’s a quick primer. Yes, there is a new 3.8 percent surtax that takes effect Jan. 1 on certain investment income of upper-income individuals — those who have an adjusted gross income of more than $200,000 as a single-filing taxpayer, or $250,000 for couples filing jointly ($125,000 if you’re married filing singly) — including some of their real estate transactions. But it’s not a transfer tax.
Sellers with an income greater than these thresholds might not be hit with the 3.8 percent tax unless they have certain types of investment income targeted by the law, specifically dividends, interest, net capital gains and net rental income. Sellers whose income is solely earned — salary and other compensation derived from active participation in a business —have nothing to worry about as far as the new surtax.
Where things can get a little complicated, however, is when a home sells for a substantial profit, and the seller’s adjusted gross income for the year exceeds the $200,000 or $250,000 thresholds. The good news: The surtax does not interfere with the current tax-free exclusion on the first $500,000 (joint filers) or $250,000 (single filers) of gain sellers make on the sale of their principal home. Those exclusions have not changed. But any profits above those limits are subject to federal capital gains taxation and could also expose sellers to the new 3.8 percent surtax.
Julian Block, a tax attorney in Larchmont, N.Y., and author of “The Home Seller’s Guide to Tax Savings,” said it will be more important than ever for sellers to pull together documentation on the capital improvements they’ve made and expenses connected with the property — including settlement or closing costs, such as title insurance and legal fees — that increase the seller’s tax “basis” in order to lower capital gains.
Since the health-care law targets capital gains, sellers could find themselves exposed to the 3.8 percent levy on the sale of their home next year. Here’s an example provided by the tax staff at the National Association of Realtors. Say a seller has an adjustable gross income (AGI) of $325,000, and sells a home at a $525,000 profit. Assuming they qualify, $500,000 of that gain is wiped off the slate for tax purposes. The $25,000 additional gain qualifies as net investment income under the health-care law, giving them a revised AGI of $350,000. Since the law imposes the 3.8 percent surtax on the lesser of either the amount the revised AGI exceeds the $250,000 threshold for joint filers ($100,000 in this case) or the amount of the taxable gain ($25,000), the seller ends up owing a surtax of $950 ($25,000 times .038).
The 3.8 percent levy can be confusing and can bite deeper when taxable capital gains are far larger or homeowners sell a vacation home or a piece of rental real estate, where all the profits could subject them to the investment surtax. Definitely talk to a tax professional for advice on specific situations.
Kenneth Harney is a syndicated real estate columnist.