I don’t know about you but I am tired of all the rumor, conjecture and urban legend surrounding so much legislation. I guess that is the power of the web but it fails to control the level of interpretation and conjecture we have to listen to – so we tend to get confused. As mortgage professionals, and real estate specialists we have had to deal with a huge data dump of information lately and it is so confusing.
Just think about the last 2 years – Nehemiah being removed for the wrong reasons, then a tax credit implemented, then it was replaced and “improved”, mortgage banking system collapse, loan programs vanishing, massive FHA changes, Fannie Mae and Freddie Mac weekly changes, loan officer licensing, and now “Obama Care” – with its hidden agendas of restrictive loan officer compensation and a housing “sales” tax of 3.8%!
I don’t know about you but that paragraph just fried my noodle! So it’s no wonder we are confused and non so much as when we listen to the coffee house myth of “every sale for a residence will be taxed 3.8% to help with Medicare. Well please enjoy the following prose because I am here to help burst the bubble of the conjecture and show it is a tax that when studied only affects a very small portion not every home owner as the media would have you believe…
The Health Care and Education Reconciliation Act of 2010 became law on March 30, 2010. It is a comprehensive and extremely complex piece of legislation. One section (1402) is entitled "Unearned Income Medicare Contribution" and does impose a 3.8 percent tax on any profit on the sale of real estate (residential or investment). But it is aimed at high-income consumers, who comprise a small majority of American citizens. And in any event, it does not take effect until Jan. 1, 2013.
Let's look at the true facts of this new law.
First, it is not a sales tax, nor does it impose any transfer or recordation tax. It is called a "Medicare" tax because the moneys received will be allocated to the Medicare Trust Fund, which is part of the Social Security system.
Next, if your individual income (technically called "adjusted gross income") is less than $200,000, you are home free. The income thresholds are clearly spelled out in the law. If you are married and file a joint tax return with your spouse, the law will apply only if your income is more than $250,000. If you and your spouse opt to file a separate tax return, the threshold is reduced to $125,000. For all other taxpayers, you have to earn more than $200,000 in order to be under the new law.
The up-to-$500,000 exclusion of gain from a home sale for married couples filing a joint tax return (or up to $250,000 for single taxpayers) has not been repealed; also, the right to deduct mortgage interest and real estate tax payment has not been eliminated.
How is the tax calculated? It is a complex formula that could be called "the accountant's protection act." As a taxpayer, you (or your financial adviser) must determine which is less: the gain you have made on the sale of your house or the amount that your income exceeds the appropriate threshold.
Complicated? Yes. Let's look at these examples. Your adjusted gross income is $150,000. You sell your house and made a profit of $400,000. There is no change in the way you determine your gain: You take your purchase price, add any major improvements you have made over the years, and subtract that number from the net sales price.
Based on this formula, you and your spouse have owned and lived in the property for at least two out of the five years before it was sold. Accordingly, you are eligible to exclude all of your profit; you are not subject to the new 3.8 percent tax. Keep the money and enjoy.
Change the example so that your adjusted gross income is $300,000. Since you are eligible to take the profit exclusion of up-to-$500,000, once again you do not have to pay the Medicare tax; your entire gain is excluded, and thus there is no profit to tax.
But let's assume you strike it rich and have made a profit of $600,000. Your income is $300,000. You can exclude only $500,000 under current law, so you will have to pay capital gains tax on the remaining balance. The rate currently is 15 percent, so you will owe Uncle Sam $15,000 ($100,000 multiplied by 15 percent).
But since your income is over the threshold, you now also have to pay the 3.8 percent tax. But on what amount?
As indicated earlier, the tax is based on lesser of your profit or the difference between the threshold and your income. Your profit is $100,000. The difference between your income and the threshold is $50,000 ($300,000 minus $250,000). In our example, the lower number is $50,000, and you will have to pay an additional $1,900 to the Internal Revenue Service (3.8 percent multiplied by $50,000).
According to statistics provided by the National Association of Realtors, in March of this year, for example, half of all existing homes sold for $170,700 or less. Clearly, none of these homes could make a profit of even $250,000, so if you qualify for the exclusion-of-gain requirements this new law will not impact you.
This new law has yet to be analyzed or interpreted. We have more than two years before it takes effect. However, since the law applies to all forms of real estate, including vacation homes, you should consider consulting with your tax and financial advisers as to your exposure.
You will, of course, have to wait until we all have a better understanding how it will work. In the meantime, however, don't believe the rumors.
Mark Taylor is a Mortgage Planner in Arizona specializing in FHA, Conventional and Jumbo loans, and helps his agents navigate through the Short Sale process with hands on experience and a comprehensive training system.
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