It isn't true. (And if you don't believe me, check with Snopes.com or FactCheck.org. Everyone believes them.) But it's easy to understand how some have been misled. The National Association of Realtors® (NAR) has been putting out "Myth Buster" commentaries on this topic since the spring of this year (2010), but the rumors persist.
Part of the problem is semantics. The health care legislation does contain a variety of new taxes, and one of them can be influenced, in certain circumstances, by a sale of real estate. (For those who like to check things out, we are talking about Section 1402 of HR 4872, the Health Care and Education Affordability Reconciliation Act of 2010 which was signed into law by President Obama on March 23, 2010.) But it's not a sales tax. If it were, it could be computed simply by knowing the facts of the sale. This tax is not that simple. Nothing that Congress does is that simple.
The new tax has been called a Medicare tax, because that is where the money will go. It is one of those taxes – to use the language of its supporters – that targets "high income" people. You know: the singles whose Adjusted Gross Income (AGI) is over $200,000 and the couples whose AGI exceeds $250,000.
To understand all this, we need the concept of "unearned income." (Bear with me now. These aren't my ideas. I'm just trying to convey what those people in Washington think.) "Unearned income", in the minds of those who live in the Beltway, is income you don't receive from your day job. It includes capital gains, rents, dividends, and interest income. To soften the concept, it is sometimes referred to as "investment income."
Now – stay with me here – for tax purposes your AGI (Adjusted Gross Income) consists of both your "regular" income (i.e. your job or your occupation) plus your net investment ("unearned") income. For most real estate professionals, who are independent contractors, the earned income would be the net Schedule C income; whereas for wage earners it would be reflected in the W-2.
Suppose you are a real estate salesperson and that your annual gross commission income was $150,000 with expenses of $75,000. That gives you $75,000 of earned income. Next, suppose you had gross rental income of $50,000 with expenses of $25,000. That gives you net investment income of $25,000. Your AGI, then, would be $100,000. (Good for you; you had a better year than a lot of us.)
Where does the sale of real estate come into all this? Well, your capital gains, if you had any, contribute – as investment income – to your AGI. Suppose the same set of facts as above, but add that during the year you sold a piece of investment real estate and realized a $50,000 capital gain. Now, your AGI for the year would be $150,000. Pretty good, but still not "high income."
So, what is the new tax? The Medicare tax applies only when AGI exceeds the limit of $200,000 for singles or $250,000 for couples. If those limits are exceeded, then the tax is 3.8% of the lesser of (1) net investment income or (2) the excess of AGI over the above-mentioned limits.
In the examples above, the limits were not exceeded, so no Medicare tax applied. There was no real estate sales tax. Next we'll look at two examples where the Medicare tax would apply.
(1) A couple earns $200,000 in their regular jobs; plus, they have net rental income of $100,000. They have exceeded the AGI limit by $50,000. The tax is triggered. Because the excess over the limit (that is, $50,000) is smaller than the net investment income of $100,000, the 3.8% tax is applied to the $50,000.
(2) This couple earns $350,000 in their occupations. A sale of investment property yielded a $50,000 capital gain; and their net rental income equaled $50,000. Their AGI is $450,000, exceeding the limit by $200,000. Their net investment income is $100,000. Because the net investment income is smaller than the excess over the AGI limit, it is the $100,000 that will be taxed 3.8%. (By the way, is this now a real estate sales tax? The sale only represented ½ the net investment income. You might just as well call it a "rent tax".) Just one more, and we'll be through. Suppose a couple earned $250,000 in their regular jobs, and that they sold their principal residence in which they had lived for ten years for a gain of $300,000. Would the Medicare tax apply? No, because they would be able to take the $500,000 exclusion. Gains from the sale would only be taxed if they exceeded that amount. Again, where's the sales tax?
David Wain Realty
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