We have been hearing frantic rumors for months about a new 3.8% sales tax or federal transfer tax on real estate. Now that the dust has settled on the presidential election, and a sudden change to existing law is unlikely, we need to deal with the law, adopted in 2010, which will be in effect very shortly.
There is a new 3.8% tax effective January 1, 2013, but it is not a sales tax, not a transfer tax, and it does not target only real estate. This tax, imbedded in the Patient Protection and Affordable Care Act, is actually a Medicare tax. Medicare and Social Security Taxes have always been paid on wages, some by each the employer and employee. However, until now, sales of appreciated property, including real estate, have been subject to capital gains tax but not Medicare or Social Security Tax.
This new provision imposes a 3.8% tax on investment income, including capital gains, dividends, interest income and net rental income, on those taxpayers who have adjusted gross income in excess of $200,000 for individual filers and $250,000 for joint filers. Importantly, the tax is only imposed on the lesser of (i) the investment income or (ii) the amount by which the income exceeds the $200,000 or $250,000 adjusted gross income thresholds. For example, if a single individual has adjusted gross income of $210,000, of which $50,000 is investment income, the 3.8% tax will be imposed on $10,000, that is, only the amount above $200,000, and not on the full $50,000 of investment income. As indicated above, capital gain from the sale of investment real estate is included within the definition of investment income. However, the current exclusion for gain on the sale of principal residences, $250,000 for individual filers and $500,000 for married filers, will continue to be applicable so that only gain above those amounts will be included as investment income.