The 3.8% Medicare Surtax and the Impact on Real Estate

Starting January 1, 2013 as a result of the Patient Protection and Affordable Care Act, higher income individuals may be subject to a new 3.8% Medicare surtax on net investment income.  The tax will impact single individuals with an adjusted gross income (AGI) above $200,000 and married couples filing a joint return with AGI above $250,000.  If a taxpayer exceeds the AGI threshold, the types of income subject to the additional 3.8% tax are capital gains (net of losses), dividends, interest, rent and royalty income (net of expenses), annuities and net income from passive business activities.

If you are a married couple that has AGI above $250,000, your net rental income and/or gain from the sale of an investment property will be subject to the additional 3.8% tax.  The tax is imposed on the lesser of net investment income or the amount by which the AGI exceeds the threshold.  For the following examples, assume a couple has wages and net passive rental income as follows:

In case 1, the couple’s AGI is below $250,000, so no portion of their passive rental income is subject to the surtax.  In both case 2 and case 3, the couple’s AGI is above the threshold and therefore their passive rental income is subject to $380 and $1,140 of additional tax, respectfully.

Would the sale of primary residence at a gain be subject to the surtax?  There is a very favorable tax law that allows a single taxpayer to have gain up to $250,000 ($500,000 for married couples) on the sale and not owe any capital gains tax.  To qualify, the home must be used as your primary residence for two out of the five years prior to the sale.  So, for an individual to be subject to the 3.8% on the sale of a primary residence, their AGI would have to be over $200,000 ($250,000 married) and the gain on the sale of their home would need to be in excess of $250,000 ($500,000 married).

If you will potentially be impacted by the Medicare surtax, consult your tax advisor about ways that you can mitigate the impact.

Article compiled for us by:
Christopher L. Lewis, CPA
Tax Manager with Cherry, Bekaert & Holland, L.L.P.
1029 Greene Street, Augusta, GA  30901
(706) 724-3557

Please consult your tax advisor regarding the applicability of the various tax laws associated with the Patient Protection and Affordable Care Act and the Health Care Act.  There are many components of the Acts that could affect your tax situation that have not been addressed in this article.  This article has been presented as information and is not intended as tax advice.