Once challenges to the law’s constitutionality reached federal courts, the e-mail warnings subsided. But with major portions of the law scheduled to take effect less than six months from now, questions are being raised again: Is there really a 3.8 percent transfer tax on real estate coming in 2013? Does it preempt the existing capital gains exclusions for home sellers, as some e-mails have claimed?
In case you’ve heard rumors or received worrisome e-mails about any of this, here’s a quick primer.
Yes, upper-income individuals face a new 3.8 percent surtax that takes effect Jan. 1 on certain investment income, including some of their real estate transactions. But it’s not a transfer tax and it’s not likely to affect the vast majority of homeowners who sell their primary residences next year. In fact, unless you have an adjusted gross income of more than $200,000 as a single-filing taxpayer or $250,000 for a couple filing jointly ($125,000 if you’re married filing singly), you probably won’t be touched by the surtax at all. (You might, however, be affected by other changes in the tax code if Congress fails to extend the Bush-era tax cuts scheduled to expire at the end of this year.)
Even if you have income above these thresholds, you might not be hit with the 3.8 percent tax unless you have certain types of investment income, specifically dividends, interest, net capital gains and net rental income. If your income is solely “earned” — salary and other compensation derived from active participation in a business — you have nothing to lose from the new surtax.
Where things can get a little complicated, however, is when you sell your home for a substantial profit and your adjusted gross income for the year exceeds the $200,000 or $250,000 thresholds. The good news: The surtax does not interfere with the current tax-free exclusion on the first $500,000 (for joint filers) or $250,000 (for single filers) of gain you make on the sale of your principal home. Those exclusions have not changed. But any profits above those limits are subject to federal capital gains taxation and possibly to the new surtax.
Julian Block, a tax attorney in Larchmont, N.Y., and author of “Julian Block’s Home Seller’s Guide to Tax Savings,” says it will be more important than ever to document the capital improvements you made to the property and the expenses connected with the house — including settlement or closing costs — because these items increase your tax “basis” and thereby lower your capital gains.
The National Association of Realtors’ tax staff provided this example of how the 3.8 percent levy might affect you next year:
Say you and your spouse have adjustable gross income (AGI) of $325,000 and you sell your home at a $525,000 profit. Assuming you qualify, $500,000 of that gain is wiped off the slate for tax purposes. The $25,000 additional gain qualifies as net investment income under the health-care law, giving you a revised AGI of $350,000. Since the law imposes the 3.8 percent surtax on the lesser of either the amount that your revised AGI exceeds the $250,000 threshold for joint filers ($100,000 in this case) or the amount of your taxable gain ($25,000), you end up owing a surtax of $950 ($25,000 times .038).
The 3.8 percent levy can be confusing, and it can bite deeper when your taxable capital gains are far larger or you sell a vacation home or a piece of rental real estate, where all the profits could subject you to the investment surtax. Definitely talk to a tax professional for advice on your specific situation.
Ken Harney’s e-mail address is firstname.lastname@example.org.