Beginning January 1, 2013, the 3.8% tax on some investment income will take effect. The most common misconception is that it is a 3.8% tax on real estate sales. Untrue. It is not a transfer tax and will not be imposed on all real estate transactions.
3.8% Tax: Who is Affected and How Much Will You Owe?
- Individuals with more than $200,000 adjusted gross income (AGI)
- Couples with more than $250,000 AGI, filing a joint return
Types of Income Subject to the Tax:
- Net Rental Income
- Capital Gains (less capital losses)
The new tax applies to the LESSER of:
- Investment income amount
- Excess of AGI over the $200,000 or $250,000 threshold
Example: Sale of Principal Residence
John and Mary sold their principal residence and realized a gain of $525,000. They have $325,000 AGI (before adding the taxable gain).
The current tax law allows exclusion of capital gain on the sale of a primary residence in the amount of up to $250,000 for individuals and up to $500,000 for married couples. The new 3.8% tax would only be imposed on the gain over this threshold amount, and even then it would depend on the other components of the AGI.
The 3.8% tax applies to whichever is less: the total investment income or the amount that the AGI exceeds the high-income threshold ($200,000 or $250,000). In John and Mary’s example, the following facts apply:
AGI before Taxable Gain: $325,000
Gain on Sale of Residence: $525,000
Taxable Gain added to AGI: $25,000 ($525,000 sale price minus the $500,000 capital gains exclusion)
New AGI: $350,000 ($325,000 + $25,000)
Excess of AGI over $250,000: $100,000 ($350,000 AGI – $250,000 threshold)
$25,000 taxable gain is less than the $100,000 excess of AGI over $250,000, so the tax applies to $25,000.
Tax Due: $950 ($25,000 x 3.8%)
NAR Brochure Illustrates 8 Scenarios
If it is still clear as mud, this should help. The National Association of Realtors has produced a 10-page brochure that explains in plain language how the tax might apply under these eight scenarios:
- The sale of a principal residence
- Sale of a non-real estate asset
- Gain, interest, and dividend from securities
- Real estate investment income
- Rental income as sole source of earnings
- Sale of second home with no rental use
- Sale of inherited investment property
- Purchase and sale of investment property
Download the PDF for easy-to-understand examples of these scenarios, and please consult with your tax adviser to be sure you understand how the tax applies to your personal situation.