If you are a homeowner hoping to sell real-estate in the near future, it’s likely that you’ve heard a thing or two about the new 3.8% Medicare tax being placed upon certain real-estate transactions. You might have even heard this slice of legislation functions as a net sales tax, applying to all homeowners completing sales transactions within the United States. That is the general conclusion when a public audience sees the number 3.8%, along with the word tax and real-estate transactions. However, for 97% of all Americans, it’s time to breathe easier: this tax doesn’t even apply to you. And for that top 3%, hang in there because it’s really not nearly as bad as it seems.
This new chunk of legislation that has been passed down through the recently passed Patient Protection Affordable Care Act (PPACA) does not call for a 3.8% sales tax on all real-estate sales. Instead, it institutes a 3.8% Medicare tax on investment income for high income households that cross a lesser of two thresholds. In fact, this tax only applies to individuals with incomes of over $200,000 and combined households with incomes of over $250,000 (so $125,000 for married taxpayers filing separate tax returns). According to the latest government statistics, this clause excludes about 97% of all tax American payers. And on top of all this, no one will have to pay the tax unless the overall profit of selling the house exceeds $250,000 per individual ($500,000 per couple). So let’s say you purchase your house for $300,000. You would need to sell the house for over $800,000 just for the tax to apply!
So for that top 3% of taxpayers with incomes over the $200,000/$250,000 limit barrier who manage to spin off their property for a profit greater than $500,000: do you really still have to pay a 3.8% tax on your real-estate sales? The answer is no. And the explanation for this is complicated (like all legislation), but not incomprehensible.
The bill implementing this new tax is long, esoteric, and (quite frankly) boring. It uses phrases like “which will generally impose a 3.8% tax on the lesser of ‘net investment income’ or the excess of modified adjusted gross income over a ‘threshold amount.’” And we wonder why everyone began to panic about a 3.8% sales tax on home sales…
So in short, what is this tax about? As said above, the tax does not apply to an overwhelming majority of American taxpayers. And even for those elite few in the top 3% of family incomes, unless a couple is selling their house for a profit over $500,000 ($250,000 per individual) their transaction still won’t apply. And, to reiterate, even for those that are required to pay this tax, it is still far from a sales tax on the overall sale of your house.
First of all, the tax formula processes two possible alternatives for taxation, and then charges the option that costs least to the taxpayer. The first option involves the direct sale price of your house. The way it would work is if you sell a house for a greater margin of profit than the said limit, the government will take the total profit of the sale, subtract the sales “threshold” ($500,000 for couples, $250,000 for individuals), and then place the 3.8% tax on the remaining amount of profit. So, if you’re interested in seeing the math worked out, let’s propose a scenario. A family buys a house for $250,000 and then some time later sells it again for $800,000. The total profit of this transaction is $550,000, thus exceeding the $500,000 dollar threshold and being subject to the 3.8% Medicare tax. Now, you would take the profit of $550,000 and subtract the $500,000 threshold to get $50,000. This is the number that would then be subjected to the 3.8% Medicare tax, amounting to a total $1,900. That’s a lot better than the $30,400 tax that might have been applied as an overall sales tax.
But to give the taxpayer options, there is a second possible route the tax could take. If the overall tax of your home ends up totaling to an excessive amount (say you bought a home for $300,000 and sold it for $1,000,000, incurring a 3.8% tax on $200,000 of profit), the tax would then apply to the amount by which the couple’s taxable income now exceeds the income threshold level (for couples, $250,000). Say after the sale, the couple’s taxable income becomes $350,000. This exceeds the $250,000 threshold by $100,000, and thus that $100,000 excess become applicable to the 3.8% tax (a total of $3,800) since it is less than the $200,000 of taxable profit from the sale of the hypothetical couple’s house.
So to close, if this all seems overly confusing and complicated to you, take comfortin the prospect that the odds are ever in your favor (there’s a greater than 97% chance this tax doesn’t apply to you). But, if after following up with the numbers and discovering your income is in the taxable range and the price you’re hoping to sell your house for exceeds a profit of $500,000, at least know that only a fraction of that total is likely to be taxed and it is going to be the lesser of two options.
And remember, I am “only” a real estate agent – not a tax accountant. So, GO GET TAX ADVICE TOO!
PS – Susan Hilton is Bryan College Station,
Texas’ real estate specialist in foreclosure sales and real estate
agent career building so if you need help –