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New 3.8% tax on investment income will affect real estate in 2013

A new 3.8% tax on investment income will take effect in 2013, and will affect many people who have rental income or who sell real estate.

The tax was included as part of President Obama’s health care law. It applies to single filers with adjusted gross income over $200,000 and married filers with adjusted gross income over $250,000. (It also applies to trusts and estates with undistributed investment income of more than about $12,000.)

The IRS hasn’t issued detailed guidance on the law, so it’s not entirely clear how it will work. However, it appears that it will apply to:

Vacation homes. If you sell a vacation home and have a capital gain, the tax will apply. If you rent a vacation home to others for more than 14 days a year, the rent (minus expenses) will be subject to the tax.

Investment property. If you have rental income from investment property, the amount (minus expenses) will be subject to the tax. But this is true only if you rent the property “on the side”; if your sole business consists of owning or operating real estate, then the rent would be considered business income and not investment income. Either way, though, if you sell investment property and have a capital gain, the gain would likely be subject to the tax.

Sale of your home. If you sell your principal residence and you have a capital gain of more than $250,000 (for single filers) or $500,000 (for married couples filing jointly), the excess will be subject to the tax.

The flat 3.8% tax applies to (1) the total amount of investment income, or (2) the amount by which adjusted gross income exceeds the $200,000 (single) or $250,000 (married) thresholds – whichever is less.

So for instance, if a single taxpayer has $225,000 in adjusted gross income and $10,000 in net rental income, the tax applies to the $10,000. But if the same taxpayer has $225,000 in adjusted gross income and $50,000 in net rental income, the tax applies to $25,000 (the amount by which the taxpayer’s adjusted gross income exceeds the $200,000 threshold).

Because the amount of the tax is significant and the details are uncertain, anyone who is affected by it would be well-advised to consult with an attorney or tax expert.

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