The tax is real but seriously overstated. Among other things, as discussed below, the tax is an income tax, not a sales tax.
Beginning in 2013, the “Affordable Care” act imposes a new 3.8% tax on investment income of taxpayers whose total income exceeds $200,000 ($250,000 if filing a joint return). The tax is imposed on the excess of the taxpayer’s income over $250,000 or the taxpayer’s total net investment income, whichever is less. For this purpose, net investment income means interest, dividends, annuities, royalties and rents, and capital gains, reduced by capital losses and other deductions specifically allocable to the investment income. Net investment income for this purpose does not include income that is generated in the ordinary course of a trade or business, nor does it include amounts received from a qualified retirement plan or IRA.
All or part of the gain (not the entire proceeds) on the sale of a home would be subject to the 3.8% tax if the taxpayer’s total income (including the gain on the home sale) exceeds $200,000 (or $250,000 if a joint return is filed). However, if the taxpayer meets the other requirements for exclusion (essentially has owned the residence and used it as the taxpayer’s principal residence for 24 months during the 60 month period immediately prior to closing the sale), the gain on sale is reduced by $250,000 (or $500,000 if the taxpayer files a joint return). The exclusion applies in determining the amount of net investment income for purposes of the 3.8% tax.
Therefore, the 3.8% tax cannot apply to you if you have owned the home and used it as your principal residence for at least 24 out of the 60 months prior to closing the sale and if the sale price is $500,000 or less if you file a joint return ($250,000 or less if you do not file a joint return). The tax also cannot apply to you if your total income, including gain on sale of the home, is $250,000 or less if you file a joint return ($200,000 or less if you do not file a joint return). If you fail both of these tests, the gain on sale of the home will be subject to the 3.8% tax to the extent your total income exceeds $250,000 or $200,000, depending on the type of return you file.
As an example of how the tax could apply, assume the seller is a married couple with total income of $150,000, before the home sale. The seller files a joint return and is eligible for the $500,000 exclusion. The seller has a tax basis of $100,000 in the home but sells it for $875,000 (which could happen if the seller owned the home for many years). After taking the $500,000 exclusion into account, the seller has a gain on the sale of $275,000. Together with the $150,000 of other income, the seller’s total income is $425,000. The 3.8% tax is imposed on the lower of the seller’s gain on the sale of the home ($275,000) or the excess of the seller’s total income over $250,000 ($425,000-250,000=$175,000). The seller thus pays the 3.8% tax on $175,000, a tax of $6,650. Of course, this is on top of the seller’s regular income tax.
If the facts are the same except that the home is the seller’s vacation home, the gain would be $775,000, the seller’s total income would be $925,000, the 3.8% tax would apply to $675,000 (total income less $250,000), and the tax would be $25,650, again in addition to the seller’s regular income tax.
The 3.8% tax is real and, in some cases will be substantial, but by no means will it universally affect home sales.
Article by Robert Warwick