Explanation of the 3.8% Real Estate TransferTax

Since the 2012 Presidential election, I have received four calls on the 3.8% Real Estate Transfer Tax issue associated with health care reform. People are fearful that it is a sales tax on real estate and are afraid to sell as a result. Thankfully, this should not prevent someone from selling, as this is not the case of an across the board real estate sales tax. The tax is NOT a transfer tax on real estate sales and similar transactions.  After the tax was enacted and added to the health care reform bill at the last minute, erroneous and misleading documents went viral on the Internet and created a great deal of misunderstanding and made the tax into something far more draconian than the actual provisions.

As reported by the National Association of Realtors

Top 10 things You Need TO know About the 3.8%  Tax

Printable pdf version of the below information

1. When you add up all of your income from every possible source, and that total is less than $200,000 ($250,000 on a joint tax return), you will not be subject to this tax.
2. The 3.8% tax will never be collected as a transfer tax on real estate of any type, so you’ll never pay this tax at the time that you purchase a home or other investment property.
3. You’ll never pay this tax at settlement when you sell your home or investment property. Any capital gain you realize at settlement is just one component of that year’s gross income.
4. If you sell your principal residence, you will still receive the full benefit of the $250,000 (single tax return)/$500,000 (married filing joint tax return) exclusion on the sale of that home. If your capital gain is greater than these amounts, then you will include any gain above these amounts as income on your Form 1040 tax return. Even then, if your total income (including this taxable portion of gain on your residence) is less than the $200,000/$250,000 amounts, you will not pay this tax. If your total income is more than these amounts, a formula will protect some portion of your investment.
5. The tax applies to other types of investment income, not just real estate. If your income is more than the $200,000/$250,000 amount, then the tax formula will be applied to capital gains, interest income, dividend income and net rents (i.e., rents after expenses).
6. The tax goes into effect in 2013. If you have investment income in 2013, you won’t pay the 3.8% tax until you file your 2013 Form 1040 tax return in 2014. The 3.8% tax for any later year will be paid in the following calendar year when the tax returns are filed.
7. In any particular year, if you have no income from capital gains, rents, interest or dividends, you’ll never pay this tax, even if you have millions of dollars of other types of income.
8. The formula that determines the amount of 3.8% tax due will always protect $200,000 ($250,000 on a joint return) of your income from any burden of the 3.8% tax. For example, if you are single and have a total of $201,000 income, the 3.8% tax would never be imposed on more than $1,000.
9. It’s true that investment income from rents on an investment property could be subject to the 3.8% tax. But: The only rental income that would be included in your gross income and therefore possibly subject to the tax is net rental income: gross rents minus expenses like depreciation, interest, property tax, maintenance and utilities.
10. The tax was enacted along with the health care legislation in 2010. It was added to the package just hours before the final vote and without review. NAR strongly opposed the tax at the time, and remains hopeful that it will not go into effect. The tax will no doubt be debated during the upcoming tax reform debates in 2013.

NAR has prepared a new guide, Top 10 Things You Should Know about the 3.8% Tax.

The tax is NOT a transfer tax on real estate sales and similar transactions.  Not long after the tax was enacted, erroneous and misleading documents went viral on the Internet and created a great deal of misunderstanding and made the tax into something far more draconian than the actual provisions.

The new tax does NOT eliminate the benefits of the $250,000/$500,000 exclusion on the sale of a principal residence.  Thus, ONLY that portion of a gain above those thresholds is included in AGI and could be subject to the tax.

(National Association of Realtors)

Of course, other tax issues could come into play in your own situation, so consult a tax attorney.

And if you’re subject to this tax, gather documents that will help you lower your capital gains hit over the years — for instance, documents noting settlement or closing costs, such as title insurance and legal fees; and improvements, such as adding a room or paving a driveway. Routine repairs or maintenance, such as painting or papering a room or replacing a broken window pane, don’t count because they don’t add to the home’s value.

The surtax, included in the law to offset the costs of healthcare reform, is expected to generate $325 billion over eight years.

This article provides general information about tax laws and consequences, but shouldn’t be relied on as tax or legal advice applicable to particular transactions or circumstances. Consult a tax professional for such advice.