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Health
Care Reform and Capital Gains
From the
NATIONAL ASSOCIATION OF REALTORS®
New Medicare Tax on "Unearned"
Net Investment Income
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New Medicare Tax on
"Unearned" Net Investment Income
Download this set of FAQs>
(PDF: 99K)
Q-1: Who will be
subject to the new taxes imposed in the health
legislation?
A: A new 3.8% tax will apply to the
“unearned” income of “High Income” taxpayers.
Another 0.9% tax will apply to the “earned”
income of many of these same individuals. Both
levies are referred to as “Medicare” taxes.
(For a description of the new 0.9% tax, see
separate Q&A entitled “New
Tax on EARNED INCOME: Wages, Salaries and
Commissions.”)
Q-2: Who is a “High Income” Taxpayer?
A: Those whose tax filing status is
“single” will be subject to the new unearned
income taxes if they have Adjusted Gross
Income (AGI) of more than $200,000. Married
couples filing a joint return with AGI of more
than $250,000 will also be subject to the new
tax. (The AGI threshold for married filing
separate returns is $125,000.)
Q-3: Are the $200,000 and $250,000
thresholds indexed for inflation?
No. Thus, over time, more individuals
may become subject to this tax.
Q-4: When does the new 3.8% Medicare
tax take effect?
A: The new Medicare tax on unearned
income will take effect January 1, 2013.
Q-5: What is “unearned” net investment
income?
A. Unearned income is the income that
an individual derives from investing his/her
capital. It includes capital gains, rents,
dividends and interest income. It also comes
from some investments in active businesses
if the investor is not an active
participant in the business.
The portion of unearned income that is subject
both to income tax and the new Medicare tax is
the amount of income derived from these
sources, reduced by any expenses
associated with earning that income. (Hence
the term “net” investment income.) Thus, in
the case of rents, the taxable amount would be
gross rents minus all expenses (including
depreciation) incurred in operating the rental
property. So if gross rents were $100,000 with
associated expenses of $40,000, net rents of
$60,000 ($100,000 minus $40,000) would be
included in Adjusted Gross Income (AGI).
Q-6: So the new tax will apply to
rents from investment properties that I own?
A: Maybe. Remember that net
investment income includes only net
rental income. Thus, gross rents would not be
subject to the tax. Rather, gross rents would
be reduced (as they are under the income tax)
by all allowable expenses, including
depreciation, cost of repairs, property taxes
and all other expenses related to the
property. AGI includes net income from rent,
so if your AGI is above the $200,000/$250,000
thresholds, then the rental income might be
subject to the tax. For many investment real
estate owners, the net rents will be the same
as or similar to the amounts reported on their
Schedule E, filed with their Form 1040 Income
Tax Return. (For calculations, see Q-8, below.
See also Q-9 through Q-12 related to capital
gain from sale of principal residence, losses
on sale and to vacation homes, below.)
Q-7: Does the tax apply to the yearly
appreciation of an asset?
No. Capital gains are subject to
this new tax only in the year when the asset
is sold. The amount of the gain will be
measured in the same way that it is for income
tax purposes. This rule applies to real estate
and all other appreciating capital assets. Net
capital gains are taxable only in the year of
sale.
Q-8: How is the new 3.8% Medicare tax
calculated?
A: The new 3.8% Medicare tax is
assessed only when Adjusted Gross Income (AGI)
is more than $200,000/$250,000. (See Q-2
above.) AGI includes net income from interest,
dividends, rents and capital gains, as well as
earned compensation and several additional
forms of income presented on a Form 1040
Income Tax Return.
The tax is NOT imposed on the total AGI,
nor is it imposed solely on the investment
income. Rather, the taxable amount will
depend on the operation of a formula. The
taxpayer will determine the LESSER
of (1) net investment income OR
(2) the excess of AGI over the
$200,000/$250,000 AGI thresholds. Thus, if net
investment income is the smaller amount, then
the 3.8% tax is applied only to the net
investment income amount. If the excess over
the thresholds is the smaller amount, then the
3.8% tax would apply onlyto the excess amount.
For example, if AGI for a single individual is
$275,000, then the excess over $200,000 would
be $75,000 ($275,000 minus $200,000). Assume
that this individual’s net investment income
is $60,000. The new 3.8% tax applies to the
smaller amount. In this example, $60,000 of
net investment income is less than the $75,000
excess over the threshold. Thus, in this
example, the 3.8% tax is applied to the
$60,000.
If this single individual had AGI if $275,000
and net investment income of $90,000, then the
new tax would be imposed on the smaller
amount: the $75,000 of excess over $200,000.
Rules of thumb for predicting the application
of this tax year to year are not readily
determinable, largely because the proportion
of net investment income compared to AGI will
vary from year to year and from individual to
individual.
Q-9: Will the $250,000/$500,000
exclusion on the sale of a principal residence
continue to apply?
A: Yes. Any gain from the sale of a
principal residence that is less than $250,000
(individual) or $500,000 (joint return) will
continue to be excluded from the income tax.
The new 3.8% tax will NOT apply to this
excluded amount of the gain.
Q-10: Will the 3.8% tax apply to any
part of the gain on the sale of a principal
residence?
A: The new Medicare tax would apply
only to any gain realized
that is more than the $250K/$500K existing
primary home exclusion (known as the “taxable
gain”), and only if the
seller has AGI above the $200K/$250K AGI
thresholds.
So, for example, if the taxable gain was
$30,000 and a married couple had AGI (which
would include the taxable gain) of $180,000,
the 3.8% tax would not apply because
AGI is less than $250,000. If that same couple
had AGI of $290,000, then the application of
the 3.8% tax would be subject to the same
formula described above. The $30,000taxable
gain on the sale would be less than the
$40,000 excess above $250,000 AGI, so the
$30,000 gain would be subject to the new 3.8%
tax.
Q-11: Is rent from a vacation home
subject to the 3.8% tax? And what about the
gain on sale of a vacation or rental property?
A: The application of the tax will
depend on whether the vacation home has been
rented out, the period for which it has been
rented and whether the property is solely for
the enjoyment of the owner. If the owner has
rented the home out to others, then the 14-day
rent exclusion will continue to apply. Thus,
if the owner rents the property to others
(including family members) for 14 or fewer
days, there would be no net investment tax.
(Note that no deductions for expenses would be
available, as under current law.)
If the home has been rented to others
(including family members) for more than 14
days, then the rents (minus related expenses)
would be considered as part of net investment
income and could, depending on AGI and the
calculations described above, be subject to
the new tax.
If the vacation home has been used solely for
personal enjoyment (i.e., there is no rental
income and no associated expenses), then a
gain on sale would be treated as net
investment income and could be subject to the
tax, depending on AGI. Similarly, if the
property had generated rents, any net gain on
sale could also be included in net investment
income. The amount of the tax (if any) would
depend on the calculation formula, above in
Q-8.
Q-12: My rental property generates a
net loss each year. How will those losses be
factored into the new tax? And what if I have
net capital losses when I sell?
A: Net losses from rents and net
capital losses reduce AGI. Thus, the losses
themselves would not be subject to the tax.
If, after losses, AGI still exceeds the High
Income thresholds, the 3.8% tax would still
apply if there were any interest or dividends
income. (Capital losses reduce capital gains.
If losses exceed gains, no more than $3000 of
capital losses may reduce other income in any
year.)
Note that passive loss limitations will
continue to apply to rental income and loss.
Q-13: All of my income is derived from
real estate investments that I own and operate
myself. Will my rents and gains be subject to
the new tax?
A: No. If the ownership and operation
of real estate you own is your sole
occupation, then those activities are what’s
called your “trade or business.” Income
derived from a trade or business is not
subject to the new 3.8% tax, but could be
subject to the 0.9% tax on earned income.
If the owner of rental properties has a “day
job,” however, real estate investments are not
considered as a trade or business, but are
rather considered as investments, even if they
are a major source of income. Note that many
Realtors engage in business activities are
that are the “typical” selling, leasing and
brokerage endeavors usually associated with
the term “REALTOR®.” If they also own real
estate assets as part of their own personal
investment portfolio, the rents from that
portfolio could become subject to the new 3.8%
tax on net investment income, depending on AGI.
Q-14: Is there a real estate “sales
tax” or a transfer tax in the new health care
bill?
A: No. There is neither a real estate
“sales tax” nor a real estate transfer tax in
the bill.
Q-15: Will “High Income Filers” lose
any portion of the Mortgage Interest they are
allowed to deduct? A: No. The
mortgage interest deduction is unchanged. No
cap was imposed on any itemized deductions.
Q-17: Why is this new tax called a
“Medicare tax?”
A: The revenues generated from this
tax will be allocated to the Medicare Trust
Fund that is part of the Social Security
System. That fund is currently on shaky
financial footing. The additional revenues
generated from the new earned income and
unearned income taxes are intended to shore up
the Medicare Trust Fund.
Q-18: How will this new tax affect
marginal (the highest) tax rates when it is
combined with existing law and with the
possible expiration of the Bush tax cuts
enacted in 2001?
A: Marginal tax rates are the tax
rates assessed on the “last” dollars included
in taxable income. If the Bush tax cuts are
allowed to expire, then the marginal rates for
upper income individuals will increase,
particularly for capital gains income.
Download the chart below to view the impact of
those changes, based on implementation of
current law effective dates.
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This information has been provide by the
NATIONAL ASSOCIATION OF
REALTORS®
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Visit one of our other websites for
additional information.
www.blueridgegarealestate.net
www.murphyncrealestate.net
www.southern-mountains.com
www.murphynchomes.com
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