Top 10 Things You Need to Know About the 3.8% Tax

We've been hearing about the confusion, rumors, and general misinformation flying around regarding the 3.8% tax. Here are some tips for clarity!

1) When you add up all of your income from every possible source, and that total is less than $200,000 ($250,000 on a joint tax return), you will NOT be subject to this tax.

2) The 3.8% tax will NEVER be collected a a transfer tax on real estate of any type, so you'll NEVER pay this tax at the time that you purchase a home or other investment property.

3) You'll NEVER pay this tax as a settlement when you sell your home or investment property.  Any capital gain you realize as settlement is just one component of that year's gross income.

4) If you sell your principal residence, you will still receive the full benefit of the $250,000 (single tax return)/ $500,000 (married filing joint tax return) exclusion on the sale of that home.  If your capital gain is greater that these amounts, then you will include any gain above these amounts as income in your Form 1040 tax return.  Even then, if your total income (including this taxable portion of gain on your residence) is less than the $200,000/$250,000 amounts, you will NOT pay this tax.  If your total income is more than these amounts, a formula will protect some portion of your investment.

5) The tax applies to other types of investment income, not just real estate.  If 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).

6) The tax goes into effect in 2013.  If you have investment income in 213, 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.

7) In any particular year, if you have NO income from capital gains, rents, interest, or dividends, you'll NEVER pay this tax, even if you have millions of dollars of other types of incomes.

8) The formula that determines the amount of 3.8% tax due will ALWAYS protect $200,000 ($250,000 on a joint return) of your income from any burden of the 3.8% tax.  For example, if you are single and have a total of $201,000 income, the 3.8% tax would NEVER be imposed on more than $1,000.

9) It's true that investment income from rents on an investment property could be subject to the 3.8% tax. BUT: The only rental income that would be included in your gross income and therefore possible subject to the tax is net rental income: gross rents minus expenses like depreciation, interest, property tax, maintenance and utilities.

10) The tax was enacted along with the health care legislation in 2010. It was added to the package just hours before the final vote and without review.  NAR strongly opposed the tax at the time, and remains hopeful that it will not go into effect.  The tax will no doubt be debated during the upcoming tax reform debates in 2013. 

*As always, refer to your CPA and financial planner for their counsel.