The New 3.8% Tax

Posted: January 4th, 2012 by Just Real Seattle

by special guest blogger Christopher Sailus, Umpqua Bank

A new tax went into effect this year that can impact some real estate sales and the net rental income derived from investment properties.Despite much of what has been written about it in numerous blogs, the new 3.8% tax is not applied to every real estate transaction, is not applicable to all tax filers as it is income sensitive, and is not applied to all the income earned.  Many are calling it the “Medicare tax” because the revenues from it are directed to the Medicare Trust Fund, with over $200 billion expected to be raised over the next 10 years.

The tax falls on some income from rents, capital gains, interest and dividends and affects those individuals with an AGI (adjusted gross income) over $200,000 and couples, if they file jointly, with an AGI over $250,000.

Two examples that are likely to come up for owners of real estate that can be affected by the new tax.  As always, seek the advice of a tax professional.

EXAMPLE 1: Rental Income from Real Estate Investment properties

Robert has a salaried job earning $100,000 a year and also owns several rental properties with the total gross rents coming to $130,000 annually.  Adding these two income numbers together brings the total well over $200,000 and might on the surface make it appear that part of Robert’s income will be subject to the new tax, but that would be incorrect.  The AGI does not consider the gross rents, it only uses the Net Income from the rental properties – or gross rents minus expenses.

So, if Robert has expenses running $110,000 a year from those properties (counting for instance, real estate taxes, mortgage interest paid, upkeep & maintenance) then his Net Income on the properties is only $20,000.  Therefore his total AGI will come to a total of $120,000, well under the threshold that triggers the tax.

EXAMPLE 2: The capital gain from the sale of a primary residence

Originally Steve & Sarah have combined income from their jobs of $150,000.  After selling their home they realize a gain of $400,000.  Again, this might appear to provide them with an AGI over $250,000, but it does not in this case.  To begin with, the new tax rule only applies if the gain of their primary residence exceeds $500,000, in their case, they were under the cap, so they are not subject to the tax.

What if they did have a gain over $500,000?  Lets imagine they had a gain of $525,000, and the law provides that the amount exceeding $500,000 is added (along with their other income) to the AGI, bringing their AGI to $175,000.  They still are not subject to the tax as their AGI is less than $250,000 for a couple filing jointly.

Somewhat complex law, and definitely worth consulting a tax adviser.

 

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