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Ask the taxgirl: “Real Estate Tax” In Health Care Law?

February 19, 2011 · 18 comments

Taxpayer asks:

Please tell me this isn’t so…..Under the new health care bill, all real estate transactions will be subject to a 3.8 % sales tax. This new tax is supposed to kick in 2013.

taxgirl says:

I’ve gotten a few questions about this so-called “real estate tax” lately. Concern about the “tax” has escalated due to a chain email making the rounds. The email, which has a few variations, looks more or less like this:

This should help stimulate the real estate market! Under the new health care bill, did you know that all real estate transactions are subject to a 3.8% “sales tax”? If you sell your $400,000 home, this will be a $15,200 tax.

You can thank Nancy, Harry and Barack for this one.

The email is so wrong on so many levels. Here’s what you need to know… Under current law, qualifying individual taxpayers are entitled to a $250,000 exclusion on the gain from the sale of a main home; qualifying married taxpayers are entitled to a $500,000 exclusion. The exclusion is on the gain from the sale, not the net sale proceeds. Gain is figured by taking the sales price and subtracting the basis. Basis is generally the original cost of your home plus capital improvements and adjustments (if you need a refresher on basis, check out this prior post).

As an example, let’s say you’re an individual taxpayer. You bought your house in 2005 for $200,000 and sold it in 2010 for $300,000, your gain is $100,000. If you qualify – meaning that you owned the home and used it as your “main home” for at least two years out of the five years prior to the sale – you’re entitled to an exclusion of $250,000. Since your gain is $100,000, you owe no capital gains tax.

This capital gains exclusion rule is still on the books. It hasn’t been changed.

The provision under the new health care law that’s stirring up all of these emails is a Medicare tax of 3.8% imposed on investment/unearned income for high income taxpayers. High income taxpayers means those individual taxpayers reporting income over $200,000 and married taxpayers filing jointly reporting income over $250,000. Investment income includes exactly what you’d think but excludes distributions from qualified retirement plans, including pensions and IRAs (meaning your retirement income won’t be surcharged despite which variation of this email you read).

Here’s where things get a little technical. Remember how I referred to the $250,000 gain (or $500,000 for married taxpayers) as an exclusion? That means it’s excluded from income. It remains excluded from income for purposes of the Medicare tax. So, no matter what your income level, those exclusions would still apply.

If your income is above the threshold and if the gain from the sale of your home is more than the exclusion, then you would be subject to the Medicare tax – but only on the non-exempt portion.

Let me give you an example. Let’s say the basis in your home, as a married taxpayer, is $400,000 and you sell your main home for $1,000,000. Your gain is $600,000. Of that, $500,000 is exempt. The overage of $100,000 would be subject to the 3.8% tax if your income was more than $250,000. The tax on your $1,000,000 sale would be, then, $3,800.

That’s a lot of “ifs.”

The tax would also apply on non-exempt sales (such as vacation homes) but again, only if your income is above the threshold.

To put this in perspective, in 2008 (the last year for which complete tax stats are available), about 3% of individual tax returns reported income of $200,000 or more. So, the potential pool of taxpayers affected by the law is, at most, 3% of taxpayers (or about 1% of the population).

For a bit of additional perspective, in 2008, the median sales price for home sales was well under the total capital gains exclusion, at a mere $181,300. Remember that the gain (not the sales price) on your home would have to exceed the exclusion before you would be subject to the new tax.

Of course, the folks who will be affected by the new tax probably aren’t happy. It probably feels unfair. But here’s the rationale behind it: taxpayers who earn their money from wages are subject to Medicare tax on those wages. There’s no exemption and, unlike Social Security tax, no cap on the wages subject to tax. But folks who earn their money from investment and other passive income (think, for example, about Steve Jobs who “earns” $1 from Apple in wages but receives stocks and other perks) don’t pay Medicare tax on that income. The idea of this new tax wasn’t to single out the real estate market or wealthy taxpayers; it’s actually an effort to ensure that all taxpayers pay tax on income.

So the bottom line is that there is no new national “real estate tax.” The Medicare tax is now being imposed on investment/unearned income for individual taxpayers making $200,000 or married taxpayers making $250,000.

If you want more information, you can check out section 9105 of the health care law. My original summary of the health care law can be found here. And if you want to read the law (which I encourage) you can download it as a pdf here. The reconciliation act – just 55 pages – can be downloaded as a pdf here.

Hopefully, that explanation makes sense. I’d love to hear what you think – chime in below with your thoughts on the tax and whether you think it’s fair.

Like any good lawyer, I need to add a disclaimer: unfortunately, it is impossible to offer comprehensive tax info over the internet, no matter how well researched or written. And remember, I love my readers but having me bookmarked on your computer doesn’t make you a client: before relying on any information given on this site, contact a tax professional to discuss your particular situation.

Have a question? Ask the taxgirl! – On twitter at http://www.twitter.com/taxgirl and on Facebook at http://www.facebook.com/taxgirl

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{ 7 comments… read them below or add one }

1 Richard February 20, 2011 at 7:13 am

In the second example involving the sale of a home for $1 million, the $100k overage would also be subject to capital gains tax of 15% for a combined tax of 18.8%, right?

2 nikos February 20, 2011 at 10:51 am

tax everywhere!! nobody cares!!

3 pmac February 20, 2011 at 12:42 pm

Just put it in an e-mail. Ninety percent of those who read it will believe it. This was debunked long ago.

4 Martina February 20, 2011 at 8:41 pm

It looks to me like the chain email is not “wrong on so many levels” but it is misleading. The tax will have a negative impact on the real estate market but I agree that the impact will be small.

5 andrea February 21, 2011 at 11:07 am

This is a modest and way too small effort to tax non wage earnings of the top 3 % of taxpayers who already pay too little. Don’t assume that these folks think this tax is unfair. They know they are getting away with paying too little taxes and many have signed a pledge to pay their fair share of taxes. I think we should avoid assuming that all of the super-rick wish to avoid taxes. They have so much money they don’t even feel it. This is a surgically designed tax to reach the untaxed non-wage earnings above the very generous capital gains exclusion for real estate. We should support it.

6 warminster estate agents October 27, 2011 at 7:31 pm

Tax is everywhere and it really sucks a lot of people especially those who are in real estate business.

7 Wild Bill November 15, 2012 at 2:32 pm

Some people are so mislead about the “3%” of tax payers!!! If 3% of the population is paying 90% of the taxes, I think they have paid their “fair” share plus the share of a lot of others!!! To be “fair,” as opposed to equal, lets have the 97% of the population NOT paying taxes, start paying their “fair” share!!! Then we are all fair! Quit thinking of it as a precentage and start thinking of it in dollar amounts of taxes paid. If you benefit, you pay. Thats a democracy.

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