Rumors are flying that the health-care
legislation Congress passed this year will impose
a sales tax on all real estate sales. But the
rumors are based only partly on fact. Although
there is a new tax, it will not apply to everyone,
and existing tax breaks for home sales will remain
The Health Care and Education Reconciliation
Act of 2010, which President Obama signed into law
March 30, is comprehensive and complex. Section
1402, "Unearned Income Medicare Contribution,"
imposes a 3.8 percent tax on profits from the sale
of real estate -- residential or investment.
But the levy is aimed at high-income
taxpayers, leaving most people untouched. And it
will not take effect until Jan. 1, 2013.
Let's look at the facts of this new law.
First, it is not a sales tax, nor does it
impose any transfer or recordation tax. It is
called a Medicare tax because the money received
will be allocated to the Medicare Trust Fund,
which is part of the Social Security system.
Next, if your adjusted gross income is less
than $200,000, you are home free. The income
thresholds are clearly spelled out in the law. If
you are married and file a joint tax return with
your spouse, the law will apply only if your
income is more than $250,000. (If you and your
spouse opt to file a separate tax return, the
threshold is reduced to $125,000 each.) For all
other taxpayers, you have to make more than
$200,000 to be covered under the new law.
The up-to-$500,000 tax-free exclusion of gain
for married couples filing a joint tax return (or
up-to-$250,000 for single taxpayers) has not been
repealed, and the right to deduct mortgage
interest and real estate tax payments has not been
How is the tax calculated? Through a complex
formula that could be called "the accountants'
protection act." As a taxpayer, you (or your
financial adviser) must determine which is less:
the gain you have made on the sale of your house,
or the amount by which your income exceeds the
Complicated? Yes. Let's look at these
examples. Your adjusted gross income is $150,000.
You sell your house and make a profit of $400,000.
There is no change in the way you determine your
gain: You take your purchase price, add the cost
of any major improvements you have made over the
years and subtract that number from the net sales
price. This assumes you and your spouse have owned
and lived in the property for at least two out of
the five years before it was sold. Accordingly,
you are eligible to exclude all of your profit;
you will not be subject to the new 3.8 percent
Now let's change the example so your adjusted
gross income is $300,000. Since you are eligible
to take the profit exclusion of up to $500,000,
once again you do not have to pay the Medicare
tax. Your entire capital gain is excluded, so
there is no profit subject to the Medicare tax.
But let's assume you strike it rich and have
made a profit of $600,000 on that home sale. Your
income is $300,000. You can exclude only $500,000
under current law, so you will have to pay capital
gains tax on the remaining $100,000. The
applicable capital gains tax rate is 15 percent,
so you will owe Uncle Sam $15,000.
And since your income is over the Medicare
tax threshold, you now have to pay the 3.8 percent
tax. But on what amount?
As indicated earlier, the tax is based on the
lesser of your profit or the difference between
the threshold and your income. In this example,
your taxable profit is $100,000. The difference
between your $300,000 income and the $250,000
threshold is $50,000. You pay the 3.8 percent tax
on the lower number, $50,000, so you will owe the
IRS an additional $1,900.
The new law has not been widely analyzed or
interpreted, and it won't go into effect
for about 2 1/2 years. However, since the
law applies to all forms of real estate, including
vacation homes, you should consider consulting
with your tax and financial advisers regarding
In the meantime, don't believe the