Some sources have characterized the so-called Medicare surtax as a transfer tax on real estate, but it’s not.
What the tax is: A 3.8% tax on investment income from some sources, such as dividends, interest payments, and capital gains; and a last-minute addition to healthcare legislation, enacted in 2010, to help shore up Medicare. It affects a limited group of high-income people.
Specifically, the 3.8% tax applies only to joint filers with an adjusted-gross income (AGI) above $250,000 ($125,000 for married couples filing separate returns) and single filers with an AGI of more than $200,000.
Another limitation is that it’s imposed on the smaller of:
1. A person’s investment income, or
2. The amount by which AGI exceeds the threshold amounts of $250,000/$125,000 or $200,000.
What the tax isn’t: The health care legislation didn’t change the existing capital gains exclusions for profits on the sale of personal residences. If you sell your home, you’re married, and you file jointly, you can still exclude up to $500,000 in profit; if you’re single or married and file separately, you can exclude up to $250,000.
You just have to own and live in the property as a principal residence for at least two years out of the five-year period that ends with the date you sell the home.
So when does the 3.8% tax kick in?
It only applies to home sale profits:
- If the profit exceeds the $500,000/$250,000 exclusion.
- When the portion of the profit above $500,000/$250,000 causes the seller’s AGI to exceed the threshold amounts.
Let’s say a couple has an AGI of $325,000 and sells their home at a $525,000 profit (not sale proceeds, but profit). $500,000 of that gain is excluded; the $25,000 isn’t, and raises their AGI to $350,000.
The couple’s revised AGI exceeds the $250,000 threshold for joint filers by $100,000. That’s more than the amount of their taxable gain ($25,000). So the 3.8% is applied to the smaller of these two amounts. They owe a surtax of $950 ($25,000 x 3.8%).
Of course, other tax issues could come into play in your own situation, so consult a tax attorney.
And if you’re subject to this tax, gather documents that will help you lower your capital gains hit over the years — for instance, documents noting settlement or closing costs, such as title insurance and legal fees; and improvements, such as adding a room or paving a driveway. Routine repairs or maintenance, such as painting or papering a room or replacing a broken window pane, don’t count because they don’t add to the home’s value.
The surtax, included in the law to offset the costs of healthcare reform, is expected to generate $325 billion over eight years.
This article provides general information about tax laws and consequences, but shouldn’t be relied on as tax or legal advice applicable to particular transactions or circumstances. Consult a tax professional for such advice.