The 2013 Medicare Tax and its Implications for Real Estate

There have been many questions floating around about the new “tax on real estate.” This is somewhat of a misnomer. Let me set the record straight.

Congress passed a bill relating to the Patient Protection Affordable Care Act (“PPACA”), sometimes referred to as “Obamacare.” The act takes effect in January 2013. There is a Medicare tax associated with this act, which will affect all real estate transactions. Some people have erroneously referred to this as a sales tax levied on the sale of a home. This is not exactly correct, though under certain circumstances the impact is the same.

This new Medicare tax is an additional charge of 3.8% on “Net Investment Income,” which is defined rather broadly but would normally include the sale of a residence. However, the tax is levied on the gain experienced by the home seller above the profit exemption currently in place, which is $250,000 for a single taxpayer and $500,000 for a couple filing jointly.

Here’s how that works:

Mr. and Mrs. Jones purchased a home for $500,000 and sold it five years later for $800,000. Since they are a couple filing jointly, they are exempt from tax on the first $500,000 of profit. Thus they are not subject to taxable gain on their tax return.

Mr. and Mrs. Smith purchased a home for $250,000 and sold it in five years for $950,000. Thus, the gain realized is $700,000. They are exempt from tax for the first $500,000. However, the excess $200,000 is subject to capital gains tax. This tax for federal, state and local is approximately 25% (25.7% for taxpayers at the highest tax rates in New York State, which begins at income exceeding $500,000). If this transaction occurred in 2013, the taxpayer would also be subject to an additional Medicare tax of 3.8% on the $200,000 profit. Thus, the tax they would have to pay would be increased from $50,000 to $57,600. It is important to note that the Medicare Tax can be an adjustment reducing profit prior to computing capital gains tax.

Let’s take the above example for Mr. and Mrs. Smith and say that they sold their home for over $1,000,000. They would also be subject to a 1% “Mansion Tax,” which is levied any home sold in New York State where the sales price is $1,000,000 or greater. The law permits the Mansion Tax to be adjusted against the selling price to calculate the income that is subject to capital gains tax. Thus, if the price were $1,000,000, the Mansion tax would be $10,000. Therefore, instead of the recognized capital gain of $200,000, it would be would be lowered to $190,000. Therefore, the capital gains tax would be $47,500 (assuming 25% rate) and the 3.8% Medicare tax would be $7,220. The full tax would be $64,720. If you add all the taxes together, it comes to 32.36%.

So, you see that the Medicare Tax is not really a real estate tax, but it is merely a tax on the gain a seller realizes that is over and above the amount that is covered by the existing profit exemption of $250,000 (single) or $500,000 (married couple).

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