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Your Legal Corner - Client Alert Blog

New 3.8% Medicare Tax May Apply to the Sale of Your Home

Written By: Melissa C. Marsh, Esq., California Attorney, October 2012 Add to Favorites
Section 1402 of the Health Care and Reconciliation Act of 2010 creates a new 3.8% unearned income Medicare tax that goes into effect January 1, 2013. This tax is imposed on individuals with an adjusted gross income above $200,000 and couples filing a joint return with an adjusted gross income exceeding $250,000. This new 3.8% tax will be imposed on income from interest, dividends, annuities, royalties, rental income (less expenses) and capital gains (less capital losses) which are not derived in the ordinary course of a trade or business, excluding active S corporation or partnership income.

How the 3.8% Medicare Tax Applies to the Sale of Your Home.

First, it should also be noted that when an individual sells his or her home any profit is considered a capital gain (unearned income). That said, for the majority of people selling their home this new 3.8% tax will not apply. First there is no sales tax on the sale of a home. Second, this new tax only applies to profit (capital gains) exceeding $250,000. Thus, any profit (capital gain) from the sale of a principal residence that is less than $250,000 (individual) or $500,000 (married filing a joint return) is excluded from the 3.8% tax.

The 3.8% Medicare tax, however, will only apply to the profit from the sale of your personal residence if: (1) the seller's adjusted gross income exceeds $200,000 if single, or $250,000 if married filing joint; AND (2) the seller sells his or her residence for a profit; AND (3) the individual's combined capital unearned income for the year from interest, dividends, annuities, the sale of stocks and bonds, and the sale of any real estate exceeds $250,000 ($500,000 if married filing joint).

Example: John Doe, a single man, has an adjusted gross income (AGI) of $155,000. Since the threshold AGI level for the 3.8% tax to apply is $200,000 it at first doesn’t appear that John Doe will be subject to the 3.8% tax. However, assume John Doe sells his home which he purchased for $200,000 back in 1998 for $500,000 (a profit/capital gain of $300,000). John Doe, as a single man, is entitled to a tax exemption of just $250,000, leaving a balance of $50,000. That $50,000 must then be added to John Doe's Adjusted Gross Income of $155,000 bringing his total AGI to $205,000 which now meets the $200,000 income threshold for a single man. Consequently, John Doe will owe the 3.8% tax on the lesser of (1) $5,000, the amount by which his $205,000 AGI exceeds the $200,000 threshold or (2) his net investment income.

How the 3.8% Medicare Tax Applies to Investment Properties, Vacation Homes and Rentals.

If ALL of your income is derived from real estate investments that you own and operate, you can let out a sigh of relief as you are not subject to the 3.8% Medicare tax. If you are a professional landlord, then your properties are considered your "trade or business" and as such are exempt from the 3.8% Medicare Tax.

If, on the other hand, you are employed or self-employed and in addition to such employment you have one or more rental properties for investment purposes, then you MAY be subject to the 3.8% Medicare tax if you meets the other threshold qualifications (AGI and capital gains).

If you merely have a second home (call it a vacation home) you would similarly be subject to the 3.8% Medicare Tax if meet both the Adjusted Gross Income (AGI) and capital gains thresholds.

Conclusion.

This article focuses on the sale of real estate and how that may trigger the 3.8% Medicare Tax. That said, please note that the 3.8% Medicare Tax applies to ALL capital gains, not just home sales (e.g. royalties, dividends, interest, annuities and rents).


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Posted In: Real Estate Reporter  Tax Update 


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Located in Los Angeles, California, the Law Office of Melissa C. Marsh handles business law and corporation law matters as a lawyer for clients throughout Los Angeles including Burbank, Sherman Oaks, Studio City, Valley Village, North Hollywood, Woodland Hills, Hollywood, West LA as well as Riverside County, San Fernando, Ventura County, and Santa Clarita. Attorney Melissa C. Marsh has considerable experience handling business matters both nationally and internationally. We routinely assist our clients with incorporation, forming a California corporation, forming a California llc, partnership, annual minutes, shareholder meetings, director meetings, getting a taxpayer ID number (EIN), buying a business, selling a business, commercial lease review, employee disputes, independent contractors, construction, and personal matters such as preparing a will, living trust, power of attorney, health care directive, and more.