3.8% New Tax Not So Scary.
You may have heard bits and pieces of the new 3.8% tax that could be applied to the sale of a principal residence beginning January 1 2013 .
There have been many rumors and mischaracterizations of this new tax, which has caused some fear and reservations in our clients decision to sell their homes. I feel I should attempt to clear up the new 3.8% tax as simple as possible so you all can understand it and take a hopeful sigh of relief.
A quick note: the National Association of Realtors stated that they believe this new tax will only apply to 2-3% of home sellers and the tax, if due by these very few, will be paid starting with your 2014 tax return and not collected in escrow.
To back up a step, the design of the new 3.8% tax was to create an estimated $210 billion fund for the planned Medicare overhaul and Obamacare. While the tax applies to interest, dividends, real estate investment income, and other matters, we will only focus here on its application to sale of a principal residence.
Here is the scoop. The 3.8% tax applies only on the lesser of the gain of the sale of your home above your home sale exemption amount or an amount over a certain adjusted gross income level. Confused yet? Let me continue with more specifics.
Taxpayers have a gain exemption on the sale of a principal residence of $250,000 for an individual filer and $500,000 for couples filing jointly (assuming the criteria is met with minimum stay in the home over a certain period of time).
Any home sale amount over the above exemption (whichever applies to you) is added to your adjusted gross income as a capital gain.
If at the end of the year your adjusted gross income, including any possible gain over the exemption above from sale of your home, is greater than $200,000 for an individual filer or $250,000 for couples filing jointly, you will pay a tax of 3.8% only on the lesser of the gain on the sale of the home or the adjusted gross income above the levels above (whichever applies to you).
I know an example will really help here.
Assume Alex and Caiti (a married couple) purchased their home 10 years ago for $500,000. They then sell the home in 2013 for $1,000,000 (a nice profit). Their profit on the sale (not including costs of sale) is $500,000. They are filing jointly so their exemption applied of $500,000 would create a $0.00 gain and the 3.8% tax will not be applied and the discussion ends there.
Assume instead that Alex and Caiti (a married couple) sold their home in 2013 for $1,100,000 (a nicer profit). Their profit here on the sale (not including costs of sale) is $600,000. After applying their joint exemption of $500,000, we are left with a gain of $100,000. We then need to go to the next step and look at their adjusted gross income level. Assume that Alex and Caiti have earnings that year, not including the gain of the home sale, of $150,000. Add to that the gain on the sale of the home of $100,000 and Alex and Caiti have an adjusted gross income of $250,000. The 3.8% tax in this case would also not be applied since their adjusted gross income does not exceed $250,000.
If Alex and Caiti's adjusted gross income exceeded the $250,000, they would pay 3.8% only on the lesser of the gain on the sale of the home or the amount their adjusted gross income exceeded the $250,000.
For example, if their total adjusted gross income in the above example was $280,000, they would then pay 3.8% on the lesser of the $100,000 gain on the sale of the home or the $30,000 amount that exceeds the $250,000 adjusted gross income level; the 3.8% tax would obviously be on the $30,000 and the tax due would be $1,140.
I really hope that was not confusing as it is meant to give you a short roadmap and realize that the 3.8% tax is not so scary and only applies to a specific set of circumstances when applied to a home sale.
As reported, in most cases, a home seller will not have to deal with this new 3.8% tax.
3.8% New Tax Not So Scary.
Jay and Michelle are not certified public accountants and the above are merely statements of opinion and do not reflect your past, current or future tax liability. Please consult with your tax advisor.