There have been a lot of rumors going around the Internet about the new 3.8% capital gains tax in the Health Care Bill also known as "Obamacare". I have received e-mails stating that the 3.8% tax will be on all real estate transactions with examples such as "if you sell your home for $100,000.00, you will owe $3800.00 in taxes, and if you sell your home for $300,000.00 you will owe $11,400.00. I have to agree that if it were true it would be devastating to the housing market, but it's not. This went around the Internet 1 1/2 years ago so I did the research on it then. It seems to be circulating again because of the upcoming presidential election. The Northeast Georgia Board of Realtors has posted this on our MLS to clarify the way it works. It's a whole lot better than the way I've been trying to explain it so I'm re-posting what they've written.
From the Northeast Georgia Board of Realtors:
The Board Office has been contacted numerous times about the 3.8% tax that everyone is talking about, receiving emails about and seeing on Facebook, so rather than continue to write individual emails we've decided to post this notice so that you might better understand what the tax really involves. The following information came from GAR.
There has been a great deal of misinformation on the 3.8% medicare tax in the Health Care Bill. There is NOT a 3.8% tax on all real estate transactions beginning in 2013. However, there is a new 3.8% tax on high income earners (Those with annual Adjusted Gross Income of $200,000+ for an individual & $250,000+ for couples) but only on unearned income (dividends, capital gains, rental income, etc.) over the AGI limits. Please keep in mind the capital gains tax exemptions remain ($250,000 for an individual, $500,000 for a married couple) for selling a primary residence.
To clear up the misinformation that is being distributed amongst membership, NAR has put together a "Myth Busters" document to clear up the confusion. This link takes you to NAR's notice concerning this matter. The link above can be found on the GAR website under Advocacy/Current Issues/Healthcare reform FAQ
This topic will also be included in the latest version of GAR's Legislative Link newsletter coming out soon.
Below is a document prepared by NAR tax analyst Linda Gould that provides real world examples:
NEW TAX ON INVESTMENT INCOME
Effective January 1, 2013
Tax Rate: 3.8% (0.038)
Applies to: Individuals with adjusted gross income (AGI) above $200,000. Couples filing a joint return with more than $250,000 AGI.
Types of Income: Interest, dividends, rents (less expenses), capital gains (less capital losses)
The new tax applies to the LESSER of:
Investment income amount
Excess of AGI over the $200,000 or $250,000 amount
Capital Gain: Sale of a Principal Residence
John and Mary sold their principal residence and realized a gain of $525,000. They have $325,000 Adjusted Gross Income (before adding taxable gain). The tax applies as follows:
AGI before taxable gain $325,000
Gain on sale of Residence $525,000
Taxable Gain (added to AGI) $ 25,000 ($525,000 - $500,000)
New AGI $350,000 ($325,000 + $25,000 taxable gain)
Excess of AGI over $250,000 $100,000 ($350,000 - $250,000)
Lesser amount (Taxable) $ 25,000 (Taxable gain)
Tax due $950 ($25,000 x 0.038)
Comment: If John and Mary had a gain of less than $500,000 on the sale of their residence, none of that gain would be subject to the 3.8% tax. Whether they paid the 3/8% tax would depend on the other components of their AGI.
Capital Gain: Sale of a Non-real Estate Asset
Barry and Michelle inherited capital assets that they have decided to liquidate. The sale of the assets generates a capital gain of $120,000. Their AGI before the gain is $140,000. They will pay the tax as follows:
AGI before capital gain $140,000
Gain on sale of assets $120,000
New AGI $260,000
Excess of AGI over $250,000 $10,000 ($260,000 - $250,000)
Lesser amount (Taxable) $10,000 (AGI Excess)
Tax due $380
Comment: In this example, only $10,000 of their capital gain is subject to the 3.8% tax. If their gain had been smaller (less than $110,000), they would not pay the $3.8% tax because their AGI would be less than $250,000.
Capital Gains, Interest and Dividends: Securities
Harry and Sally have substantial income from their securities investments. Their AGI before including that income is $190,000. Their investment income is as follows:
Interest Income (Bonds, CDs) $60,000
Dividend Income $75,000
Capital Gains $10,000
Total Investment Income $145,000
New AGI $335,000 ($190,000 + $145,000)
Excess of AGI over $250,000 $ 85,000 ($335,000 - $250,000)
Lesser amount (Taxable) $ 85,000 (AGI excess)
Tax Due $ 3,230 ($85,000 x .038)
Rental Income: Income Sources Including Real Estate Investment Income
Hank has a day job from which he earns $85,000 a year. He owns several small apartment units and receives gross rents of $130,000. He also has expenses related to that income.
AGI before rents $85,000
Gross Rents $130,000
Expenses (including depreciation) $110,000
Net Rents $20,000
New AGI $105,000 ($85,000 + net rents)
Excess of AGI over $200,000 $0
Taxable amount $0
Tax due $0
Comment: Even though Hanks combined gross rents and day job earnings exceed $200,000, he will not be subject to the 3.8% tax.
Rental Income: Rental Income as Sole Source of Earnings Real Estate Trade or Business
Henriettas sole livelihood is derived from owning and operating commercial buildings. Her income stream is as follows:
Gross rents $750,000
Expenses (including depreciation) $520,000
Net rents $230,000
AGI (net rental income) $230,000
Excess of AGI over $200,000 $ 30,000
Taxable amount $0
Because Henriettas rental income is from a trade or business and therefore not treated as investment income, she is NOT subject to the 3.8% investment income tax.
Comment: Henrietta IS subject to the new 0.9 tax on earned income, however, because some portion of the net rents represents her compensation for operating the commercial buildings.
For this example, assume that the total net rents are her sole compensation. The tax on this earned income would be as follows:
Excess of AGI over $200,000 $30,000
Tax due $270 ($30,000 x .009)
Comment: Depending on how Henrietta has organized her business (S Corp, LLC or sole proprietor), she might be able to pay herself $175,000, leaving the remaining $55,000 in the business in anticipation of making improvements the following year. In that case, because her AGI of $175,000 is less than $200,000, she will owe neither the unearned income tax (3.8%) nor the earned income tax (0.9%).
Sale of a Second Home with No Rental Use (or no more than 14 days rental)
The Bridgers own a vacation home that they purchased for $275,000. They have never rented it to others. They sell it for $335,000. In the year of sale they also have earned income from other sources of $225,000. The 3.8% tax applies as follows:
Gain on sale of vacation home $60,000 ($335,000 - $275,000)
Income from other sources $225,000
AGI $285,000 ($60,000 + $225,000)
Excess of AGI over $250,000 $35,000 ($285,000 $250,000)
Capital Gain $60,000
Taxable (Lesser) Amount $35,000
Tax Due $1330
Comment: If the Bridgers rent the home for 14 or fewer days in the course of a year, the rental income is non-taxable and the results in the year of sale will be the same as shown above. If the rental period exceeds 14 days in any year, then the rental income (less expenses) will be taxable and AGI would include not only the capital gain, but also some amount that is depreciation recapture. (See example below.)
Sale of an Investment Property (Residential or Commercial)
In 2010, Ethan inherited a four-plex investment property from his great aunt. She had used it for many years as an investment rental property in San Francisco. At the time of her death, the adjusted basis of the property was $10,000. During her period of ownership, she had taken $240,000 of depreciation deductions on it. Its fair market value was $900,000 when she died. Because there was no estate tax for 2010 and because carryover basis was in effect, Ethans basis in the inherited property is also $10,000. The prior depreciation allowances carry over to him, as well. He continues to use the property as an investment rental property.
In 2015, Ethan sells the property for $1.2 million. He is single and reports Schedule C income of $180,000. The 3.8% tax will affect Ethan as follows:
Gain on Sale $1,190,000 ($1.2 million - $10,000)
Depreciation Recapture $240,000 (From Great Aunt)
Depreciation Recapture $2,200 (Ethan -- approximate)
Total Gain $1,432,200
Schedule C Income $ 180,000
Adjusted Gross Income $1,612,200 (Gain + Schedule C)
Excess over $200,000 $1,412,200
Taxable Amount $1,412,200
Tax Due $54,664
Comment: If Ethan had inherited the property in a year when stepped-up basis was in effect, his basis would have been $900,000. The capital gain in this example would have been only $300,000. Ethan would not have been responsible for his great aunts depreciation recapture amount. His own depreciation recapture amount would have been based on depreciation allowances on a basis of $900,000 rather than $10,000. Thus, while he would still have been liable for the 3.8% tax, the amount of tax would be substantially smaller. (Exclusive of any depreciation recapture amount, the tax due would be $10,640. His capital gain would have been $300,000.) The results would be the same if Ethan had purchased the property for $900,000.