2013 Medicare Tax On Home Sales

The Obama administration and Congress recently passed health care legislation imposing a new federal tax that takes effect on January 1, 2013. The legislation we are talking about is Section 1402 of the Health Care and Reconciliation Act of 2010 (part of the Patient Protections and Affordable Care Act). Commonly referred to as the “Medicare Tax,” the proceeds from this new tax will be allocated to the Medicare Trust Fund, which has been experiencing a bit of financial instability lately. The new legislation imposes a 3.7% tax on “unearned income” of “high income taxpayers.” So, what does that really mean?

2013 Medicare Tax – What It Means To Home Buyers and Sellers

Who is a “high income taxpayer?” If your filing status is “single,” you are considered a high income taxpayer if your adjusted gross income (AGI) is greater than $200,000. If your filing status is “married filing jointly,” you are a high income taxpayer if your AGI is greater than $250,000.

What is “unearned income?” It includes any income you derive from investing your capital. For example, it will include capital gains (only in the year the asset is sold), dividends, interest income and rents. It might also include investments in active businesses – but only if you are not an active participant in that business.

Now here’s where it gets a bit tricky. The 3.8% tax does not apply to all unearned income. It only applies to the net unearned income.  So, you’ll take the amount of income earned from those sources (capital gains, dividends, interest income, rents, and investments) and subtract the amount of expenses associated with earning that income. This is your net investment income. Once you have this number, compare it with your excess of AGI (over the $200,000/$250,000). The 3.8% tax is imposed on the lesser of these two numbers.

Example: You’re a single individual with an AGI of $280,000. Therefore, your excess of AGI is $80,000. Your net investment income is $75,000. The 3.8% Medicare Tax will be applied to the $75,000 (the smaller number).

Selling A Home? Some Sellers Pay Medicare Tax & Some Won’t

There is an existing primary home exclusion (called the “taxable gain”) of $250,000 for individuals and $500,000 for married couples filing jointly. If you sell your primary residence and your gain from the sale is less than those amounts, the Medicare Tax will not apply. However, if your gain from the sale is over the $250,000/$500,000 exclusion, the 3.8% tax will apply to the gain if you’re a high income taxpayer.

I’m Selling A Rental Property, Do I Pay 3.8 Percent Medicare Tax?

Your net investment income includes your net rental income. Your net rental income is determined by subtracting your allowable expenses (depreciation, property taxes, repair costs, etc…) from the gross rents. This amount is added to any other sources of income that qualify as net investment income. The same rules discussed above apply here. So, your net rental income might be subjected to the 3.8% tax – just depending on all the factors.

If you earn all of your income from real estate investments that you own/operate yourself, the income you derive from these real estate investments will not be taxed under the new Medicare tax.

The new Medicare Tax seems a bit tricky, but it’s relatively simple once you understand the basic guidelines surround the legislation. If you’re concerned about how the new Medicare Tax will affect you when buying or selling a home after January 1, 2013, we would be happy to help you understand the details.