The Federal 3.8% Tax Myths & Facts
The federal Patient Protection and Affordable Care Act includes a new tax directed at upper income taxpayers, which will go into effect on January 1, 2013. The 3.8% tax is imposed ONLY on those with more than $200,000 of Adjusted Gross Income (AGI) ($250,000 on a joint return). The tax applies to investment income, defined as interest, dividends, capital gains and net rents, this includes home sales. A formula will determine what portion, if any, of these types of investment income would be subject to the tax.
The tax is NOT a transfer tax on real estate sales and similar transactions and does NOT eliminate the benefits of the $250,000/ $500,000 exclusion on the sale of a principal residence.
Not long after the tax was enacted, erroneous and misleading documents went viral on the Internet and created a great deal of misunderstanding. With the recent U.S. Supreme Court ruling upholding the Act, questions and rumors about the tax are beginning to circulate again. REALTORS® should familiarize themselves with the tax, but should not advise their clients about the application of the tax. To learn more, view NAR’s informational page which includes FAQ’s, a brochure, and a video on the topic.
Click Here for the NAR article. It includes links to the digital version of the brochure, FAQs, as well as a video.
Example: Sale of Principal Residence
John and Mary sold their principal residence and realized a gain of $525,000. They have $325,000 AGI (before adding the taxable gain).
The current tax law allows exclusion of capital gain on the sale of a primary residence in the amount of up to $250,000 for individuals and up to $500,000 for married couples. The new 3.5% tax would only be imposed on the gain over this threshold amount, and even then it would depend on the other components of the AGI.
The 3.8% tax applies to whichever is less: the total investment income or the amount that the AGI exceeds the high-income threshold ($200,000 or $250,000). In John and Mary’s example, the following facts apply:
AGI before Taxable Gain: $325,000
Gain on Sale of Residence: $525,000
Taxable Gain added to AGI: $25,000 ($525,000 sale price minus the $500,000 capital gains exclusion)
New AGI: $350,000 ($325,000 + $25,000)
Excess of AGI over $250,000: $100,000 ($350,000 AGI – $250,000 threshold)
$25,000 taxable gain is less than the $100,000 excess of AGI over $250,000, so the tax applies to $25,000.
Tax Due: $950 ($25,000 x 3.8%)
Here is a link to the NAR brochure, The 3.8% Tax Real Estate Scenarios & Examples, about this new tax.
Thank you for reading this post. If I can ever be of help in finding you the perfect property here in the Napa Valley, please email me at Curtis@NapaValleyAddress.com