Obamacare Tax

Obama Care 3.8% Tax On Your Investment Real Estate Profits?

Buzzard photograph ©

copyright Caroline Gerardo


1.      The tax applies to investment income, not just real estate. When 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).

2.      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. There is still time to plan, because I don't see anyone protesting about paying this.

3.      If you have no income from capital gains, rents, interest or dividends, you will not have to pay this tax, even if you have millions of dollars of other types of income.

4.      The formula that determines the amount of 3.8% tax due will always protect $200,000 ($250,000 on a joint return)  For example, if you are single and have a total of $201,000 income, the 3.8% tax is imposed on  $1,000.

5.      Investment income from rents on an investment property is 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. Most borrowers income taxes that I review who have rental properties tend to net negative numbers. In other words - once they pay their mortgage, taxes, insurance, repairs, depreciation and... they aren't paying income tax on the rental.

6.      The tax was bundled with the health care legislation in 2010. It was SLIPPED to the package just hours before the final vote and without review. National Association of Realtors fought the tax and the tax will be debated during the upcoming tax reform debates in 2013. Why is this not in the news?

7.      The health care reform package (the Patient Protection and Affordable Care Act and the Health Care and Education Reconciliation Act of 2010) imposes a new 3.8 percent Medicare contribution tax on the investment income of higher-income individuals. Although the tax does not take effect until 2013, start examining methods to lessen the impact of the tax today. A few methods come to my mind -prepare now: reduce income by deferring, putting into retirement,

8.       “Net investment income” includes interest, dividends, annuities, royalties and rents and other gross income attributable to a passive activity. Gains from the sale of property not used in an active business and income from the investment of working capital are also treated as investment income. Further, an individual’s capital gains income will be subject to the tax. This includes gain from the sale of a principal residence, unless the gain is excluded from income under Code Sec. 121, and gains from the sale of a vacation home. However, contemplated sales made before 2013 would avoid the tax.

9.      This tax also applies to estates and trusts, on the lesser of undistributed net income or the excess of the trust/estate adjusted gross income (AGI) over the threshold amount ($11,200) for the highest tax bracket for trusts and estates, and to investment income they distribute.

10. Net investment income is gross income or net gain, reduced by deductions that are “properly allocable” to the income or gain. This is a key term that the Treasury Department expects to address in guidance, and which we will update on developments. For passively-managed real property, allocable expenses will still include depreciation and operating expenses.
11. For real estate with capital gains, this formula puts RED Alert on amounts that increase your property’s basis. It also focuses on investment expenses that may reduce net gains: interest on loans to purchase investments, investment counsel and advice, and fees to collect income. Other costs, such as brokers’ fees, may increase basis or reduce the amount realized from an investment. As such, taxpayers may want to consider avoiding installment sales with net capital gains (and interest) running past 2012. Sellers need to look carefully at what they will net on capital gains on sales of real estate before they list. A few suggestions here: 1031 Exchange, even though the Orange County Real Estate market is increasing- in Newport Beach and Laguna Beach prices have risen about 16-18% - Sellers need to look carefully at capital gain before they close the sale.

12. The tax applies to the lesser of net investment income or modified AGI above $200,000 for individuals and heads of household, $250,000 for joint filers and surviving spouses, and $125,000 for married filing separately. MAGI is your AGI increased by any foreign earned income otherwise excluded under Code Sec. 911; MAGI is the same as AGI for someone who does not work overseas.

    For example: A single individual, with modified AGI of $220,000 and net investment income of $40,000. The tax applies to the lesser of (i) net investment income ($40,000) or (ii) modified AGI ($220,000) over the threshold amount for an individual ($200,000), or $20,000. The tax is 3.8 percent of $20,000, = $760. The tax is not applied to the entire $40,000 of investment income.


13.   The tax does not apply to distributions from qualified plans, 401(k) plans, tax-sheltered annuities, individual retirement accounts (IRAs), and eligible 457 plans. But there is no exception for distributions from nonqualified deferred compensation plans subject to Code Sec. 409A. You can defer income, but be careful pulling it all out at once and exceeding the $200000. mark.  However, distributions from these plans (including amounts deemed as interest) are generally treated as compensation, not as investment income.

14. The exception for distributions from retirement plans suggests that potentially taxable investors may want to shift wages and investments to retirement plans such as 401(k) plans, 403(b) annuities, and IRAs, or to 409A deferred compensation plans. Increasing contributions will reduce income and may help you stay below the applicable thresholds. Small business owners may want to set up retirement plans, especially 401(k) plans. If you have not yet established a plan, I suggest  you open one and consider increasing contributions to keep your income under $200000.  

15. Another exception is provided for income ordinarily derived from a trade or business that is not a passive activity under Code Sec. 469, such as a sole proprietorship. Small business owners may avoid the tax and investment income from an active trade or business is excluded. However, SECA (Self-Employment Contributions Act) taxes still remain intact to proprietors and partners. Income from trading in financial instruments and commodities over the income numbers will be paying the 3.8% tax.

This may be boring tax news, but very important for Realtors to advise clients who are selling high end Jumbo multi million dollar property. "Mine government" is not yet charging new larger transfer taxes in California, but this 3.8% Federal tax on the wealthy wage earner (I say this because business owners and corporations know how to write off income to avoid the $200,000. income number while w-2 earners like myself will worry about paying this). 
This is not tax advice, just news to plan around if you are a w-2 income earner who works hard and makes a good deal of money.


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