By Jack Hagel and Alistair M. Nevius, J.D.
July 30, 2012
The National Association of Realtors has some tax advice for users of the internet: Don’t believe everything you read.
There has been a recent flare-up of chain emails purporting that, come Jan. 1, all real estate transactions will be subject to a 3.8% federal sales tax. The problem: That’s not true.
“This is grossly inaccurate,” said Stephanie Singer, a spokeswoman for the Washington-based Realtors association. “It’s not a sales tax on all properties.”
The basis for the rumors is the new 3.8% Medicare tax on unearned income, which will take effect next year (Sec. 1411). That provision provides the rumors with a kernel of truth: A very small number of taxpayers will pay a surtax on gain from the sale of a principal residence. The new tax will only apply to single taxpayers with a modified adjusted gross income (MAGI) in excess of $200,000 and married taxpayers with a MAGI in excess of $250,000 if filing a joint return, or $125,000 if filing a separate return. Those taxpayers will pay the tax on gain from sale of a principal residence, but only on the amount of gain that exceeds the thresholds in Sec. 121 ($250,000 for single taxpayers; $500,000 for joint returns).
False rumors about a wider-reaching real-estate tax began to find their way to inboxes in 2010, when Congress passed sweeping health care reform legislation (the Patient Protection and Affordable Care Act, P.L. 111-148, and the Health Care and Education Reconciliation Act of 2010, P.L. 111-152)—the same legislation opponents have dubbed “Obamacare”—which was the genesis of the Medicare tax.
Since June, when the U.S. Supreme Court upheld the legislation, there has been another spike in email-rumor activity, said Singer, who noted that the Realtor association does not have a position on the legislation.
As a result of the rumors, tax practitioners have been getting questions from concerned clients. The first thing for practitioners to convey to clients is that the “real estate sales tax”—at least, the version described in some emails—is largely a hoax. Practitioners should then be prepared to explain the facts:
- The new tax would only apply to single taxpayers with a modified adjusted gross income (MAGI) in excess of $200,000 and married taxpayers with a MAGI in excess of $250,000 if filing a joint return, or $125,000 if filing a separate return.
- The tax is equal to 3.8% of the lesser of the taxpayers’ “net investment income” or the amount by which their MAGI exceeds the threshold amount.
- Under Sec. 1411(c)(1)(iii), net gain attributable to the disposition of property (other than property held in an active trade or business) is subject to this tax. That means taxable gain on the sale of a personal residence in excess of the Sec. 121 exclusion amount would be included. Sec. 121 provides that taxpayers may exclude up to $250,000 ($500,000 for joint returns) from the gain on the sale or exchange of a principal residence provided they meet certain ownership and use requirements.
- Only taxpayers with MAGI over $200,000 (or $250,000 if married filing jointly) who sell their principal residence and realize more than $250,000 in gain ($500,000 if married filing jointly) will be subject to the 3.8% tax and only on the amount of gain they realize over the Sec. 121 threshold (and on their other net investment income).
Example: A married couple with MAGI of $325,000 purchased a home in California many years ago for $350,000 and sold it this year for $900,000, realizing a gain of $550,000. After excluding $500,000 gain under Sec. 121, they are left with $50,000 investment income (assume they have no other investment income). Since their AGI is $75,000 over the tax’s threshold amount for married taxpayers filing jointly, the lesser amount of $50,000 would be subject to taxation. At 3.8% they would owe $1,900.