Is there a 3.8% Affordable Care Act Tax on the sale of Real Estate?
The Affordable Care Act (ACA), often referred to as Obamacare, was signed into law by President Barack Obama on March 23, 2010 and went into effect in 2013.
The law is a Federal law that pertains to health care and health insurance, but is relevant to homeowners because it instituted a 3.8% tax on the net investment income of certain high earning taxpayers, including upon the net investment income on the sale of a home.
I’ll break down exactly who will pay the tax (and how much), but for now it’s easier to simply state that the tax is intended to raise general revenue to be used, among other things, to administer the Affordable Care Act.
Let’s start by saying right out of the gate that most people will not pay the 3.8% ACA tax upon the sale of their home. This is because there are a number of exclusions that exempt most homeowners.
The people most likely to pay the tax are high-income earners and certain real estate investors.
This is because the tax is effectively a capital gains tax triggered by the sale of a capital asset like a home. It’s not a sales tax or a transfer duty tax as it taxes the capital gain not the sales proceeds.
Let’s go back to the exclusions that exclude most home sellers from paying the tax.
The following exclusions apply:
1. The tax is only payable by high-income earners with adjusted gross income (AGI) exceeding $250,000 for joint filers or $200,000 for individual filers, with no indexing for inflation.
It’s important to note that this is your adjusted gross income so you get to write off all your approved deductions from your gross annual income.
But also note that when you make “unearned income” on things like sale of stocks, interest, dividends and the sale of your home, this income must be added to your adjusted gross income
In short, if you and your spouse don’t earn more than $250,000 AGI you won’t pay the tax.
2. This is a capital gains tax so it only calculates the tax based on the gain in your home’s value, not the proceeds from the sale.
In calculating your capital gain you are able to make a number of deductions from the sale price, including the base cost of the asset and a number of costs of owning and selling your home.
3. The current capital gains tax laws exclude taxation on gains on your primary home of up to $500,000 for joint owners or $250,000 for single owners.
This means that when you and your spouse sell your primary residence the first $500,000 gain is excluded from any capital gains tax.
As always, the devil is in the detail, but as a general rule of thumb you won’t pay the ACA 3.8% tax if you and your spouse earn less than $250,000 (adjusted gross income) or your capital gain on the sale of your primary home is less than $500,000.
This effectively excludes 97% of primary homeowners from paying the ACA tax.
Note that this exclusion applies to the sale of your primary residence.
The question that arises is what happens when you sell a second home or an investment property?
The answer is quite complicated and varies according to your personal circumstances and how you used the property. Did you rent it out, how much rent did you get, did you receive interest or dividend income, do you have any capital losses, how did you structure your company, is it business or investment income?
Note that a full time investor, with no day job, can classify rental income as trade or business income and not investment income. This will exclude the 3.8% ACA tax as it applies to investment income. However there is as second law enacted to tax earned income, like rental income, at a rate of 0.9%, designed to fund additional costs to Medicare.
It’s also important to note another wrinkle in that the new tax applies to the LESSER of the Investment Income Amount or the EXCESS of income over $200,000 (single) or $250,000 (joint).
Needless to say, you should consult with your tax advisor.
This National Association of Realtors provided a number of excellent examples in this Affordable Care Act information brochure.