Service Request

Medicare Real Estate Tax?

Submitted by S. Leonhard
Beginning this year, property owners now face a new 3.8% surtax that is part of the Affordable Care Act passed in 2010.This tax was introduced just hours before the final debate on health care legislation as a means of extending the life of the Medicare Trust Fund which is projected to run out of funding in just a few short years.

While there is still guidance needed from the IRS, we do know that the tax applies to many forms of investment income including interest, dividends, capital gains and rental income.  It is not a sales tax and will not apply to the gain on the sale of a personal residence that is currently excluded from income under the current law.  Currently individuals can exclude up to $250,000 of the gain on the sale of their principal residence and joint filers can exclude up to $500,000.  However, it may affect property owners with a very large gain on the sale of a personal residence or with a gain on the sale of a vacation home or investment real estate.

The tax will apply to individuals with more than $200,000 in adjusted gross income (AGI) and married couples filing jointly with income over $250,000.   These AGI thresholds are not indexed to inflation so the tax with impact more taxpayers over time.
The 3.8% tax is imposed on the lesser of the net investment income or the amount that AGI exceeds the thresholds discussed above.  The National Association of Realtors provides these examples:

Primary residence
Say a married couple sells their principal residence for a $530,000 profit. Their taxable gain would be $30,000 ($530,000 minus $500,000). If their adjusted gross income, including the gain, is $180,000, they won’t owe any surtax because their income falls under the $250,000 threshold.  If their adjusted gross income is $290,000, however, the surtax will be assessed on the $30,000 gain, because that is less than the $40,000 that their income exceeds the threshold ($290,000 minus $250,000).  What if their taxable gain on the sale of the house is $50,000? The surtax will be assessed on the $40,000 excess above the threshold, because $40,000 is less than $50,000.

Vacation home
Now say a couple has adjusted gross income of $225,000, before a $60,000 gain from the sale of a vacation home. Since the gain does not qualify for the income-tax exclusion (because it isn’t from the sale of their principal residence), it pushes their adjusted gross income to $285,000, or $35,000 above the threshold.  In this case, the surtax will apply to the couple’s $35,000 “excess” income, since $35,000 is less than $60,000.  If the couple rents out the house for 14 or fewer days in a year, the rental income isn’t taxable and, therefore, should not be subject to the surtax.  But any gain from a sale could be.  If they rent it for more than 14 days, the rental income (minus expenses) is generally taxable and could be subject to the surtax, as could any sale profit.

Investment property
If the vacation home is solely a rental property, it is treated as an investment property for tax purposes. Here the rules for applying the Medicare tax are even more complex and somewhat unsettled.  In general, someone with a day job who collects rents on the side must include that income (net of expenses) in investment income, potentially subjecting it to the surtax, while someone whose sole occupation involves owning and operating real estate typically would not be subject to the tax. In either case, any profits from a sale could get hit with the surtax.  If you think any of these situations may apply to you, please be sure to contact a trusted tax advisor!

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