The 3.8% real estate tax on home sales. Truth or Fiction?

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real-estate-sales-taxBack in April of 2010, the massive health care bill that was signed into law. In the final hours, lawmakers injected a provision to impose a 3.8% tax on the sale of some residential properties in some circumstances.

As often tends to happen, a whole lot of misinformation soon commenced to be spewed forth. Here we are, almost a year later and the misinformation continues to crop up from time to time.

And as we enter into an election cycle, you’re sure to see more and more emails like this:

real-estate-sales--tax-email

Some things to remember:

1) Don’t believe everything you read on the internet.

2) Or in an email.

3) Emails with five different text colors and three different type faces and two different font sizes should almost always be ignored.

Here’s the real scoop on this 3.8% tax

Yes, effective January 1, 2013 there is a POTENTIAL 3.8% tax that will be imposed on SOME income generated from SOME home sales.

No, it is not a “real estate sales tax,” or a “transfer tax” and it does not apply to every home that is sold.

In fact, the 3.8% tax will apply to very few people in very few circumstances.

Before I attempt to delve into the details, it should be noted IN BIG RED LETTERS: I am not a tax professional, nor do I play one on the Internet. In fact, I have zero desire to be a tax professional. As always, your specific tax questions should be addressed to a tax professional, not a real estate broker writing a blog post. SEEK PROFESSIONAL HELP.

If you read through the actual legislation, it is easy to see how so many people have screwed up what this 3.8% tax is really all about. Here is just a taste for you:

SEC. 1411. IMPOSITION OF TAX.
(a) IN GENERAL.—Except as provided in subsection (e)—
(1) APPLICATION TO INDIVIDUALS.—In the case of an individual, there is hereby imposed (in addition to any other tax imposed by this subtitle) for each taxable year a tax equal to 3.8 percent of the lesser of—
(A) net investment income for such taxable year, or
(B) the excess (if any) of—
(i) the modified adjusted gross income for such taxable year, over
(ii) the threshold amount.
(2) APPLICATION TO ESTATES AND TRUSTS.—In the case of an estate or trust, there is hereby imposed (in addition to any other tax imposed by this subtitle) for each taxable year a tax of 3.8 percent of the lesser of—
(A) the undistributed net investment income for such taxable year, or
(B) the excess (if any) of—
(i) the adjusted gross income (as defined in section 67(e)) for such taxable year, over
(ii) the dollar amount at which the highest tax bracket in section 1(e) begins for such taxable year.
(b) THRESHOLD AMOUNT.—For purposes of this chapter, the term ‘threshold amount’ means—
(1) in the case of a taxpayer making a joint return under section 6013 or a surviving spouse (as defined in section 2(a)), $250,000,
(2) in the case of a married taxpayer (as defined in section 7703) filing a separate return, 1?2 of the dollar amount determined under paragraph (1), and
(3) in any other case, $200,000

Please, kill me now. Does that make sense to anyone?

Let’s try it in language normal people can understand

Rather than give myself a migraine trying to re-write the pages of gibberish produced by Congress and their batteries of lawyers, CPA’s and God only knows what else, I’ll let the National Association of Realtors (NAR) do the dirty work. Say what you want about the NAR, but they obviously have a vested interest in any legislation that could affect the real estate market, agents and/or home buyers and sellers. So they’ve spent a LOT of time understanding this tax, and they communicate it pretty well. In The 3.8% Tax Is not a Real Estate Transfer Tax, Robert Freedman, Senior Editor of Realtor Magazine, says this:

Here’s how the tax works. For individuals earning $200,000 a year or more and married couples earning $250,000 a year or more, certain investment income above these income levels might be subject to the 3.8 percent tax on a portion of that income. I say “might” because whether the tax applies or not depends on many factors having to do with the kind and amount of the investment income the household receives.

Investment income includes capital gains, dividends, interest payments, and, for those who own rental property, net rental income.

Importantly, the $250,000 (for individuals) and $500,000 (for married couples) capital gain exclusion on the sale of a principal residence remains in place. So, if you’re a married household that sold a house for a $500,000 gain (that’s gain, not sale proceeds), that amount remains excluded from your income calculation.

The NAR has also prepared a brochure that looks at how the tax might apply under eight income scenarios: 1) sale of principal residence, 2) sale of a non-real estate asset, 3) gain, interest, and dividend from securities, 4) real estate investment income, 5) rental income as sole source of earnings, 6) sale of second home with no rental use, 7)  sale of inherited investment property, and 8) purchase and sale of investment property.

This brochure does a nice job with simple math and explanations covering various scenarios the tax might apply to.

And if you want even more details, in relatively tax-code free speak, read the NAR’s FAQ on the “New Medicare tax on ‘Unearned” net Investment Income” (as the “3.8% real estate tax is officially, and more accurately, called).

Hopefully this helps clear some of the confusion.

Probably not. But I swear if I see one more real estate “professional” claiming all home sales are going to be subject to a sales / transfer tax, I think my head will explode.

Even more accurate resources for information on the “3.8% real estate tax”

Top 10 Things You Need to Know About the 3.8% Tax (National Association of Realtors)

A 3.8 Percent “Sales Tax” on Your Home? (FactCheck.org)

A Sales Tax When You Sell Your Home? (MoneyTalksNews)

3.8% “Real Estate Sales Tax” thanks to Health Care Legislation? (Matt Stigliano RERockstar)

 

Photo Credit: David Reber’s Hammer Photography on Flickr. CC Licensed.

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About the Author
Jay Thompson

I'm a real estate broker in Phoenix, Arizona and the publisher of the Phoenix Real Estate Guy blog. I tend to drive too fast and scream at the University of Texas and Denver Broncos football teams. My two kids are smarter than most adults I know and my wife is simply amazing.

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