Tax Truths

This past week I was at a lunch where a real estate professional was bemoaning the “house tax” associated with the Affordable Care Act.  When I suggested that the health care legislation didn’t include a house-tax I was met with much skepticism.  I explained there was a capital gains tax change that could involve houses, but that didn’t get much traction.  Finally someone used their iPhone to visit an Internet site that confirmed that the tax increase relates to capital gains.  While it’s possible to pay capital gains tax on the sale of your primary residence – it’s unusual. (Right now it’s unusual for a house to sell for more than it cost in the first place!)  In an effort to expand my outreach on this subject, I thought it would be helpful to go into more detail here.

Part of the health-care overhaul legislation includes a new 3.8% Medicare tax on “unearned” net investment income.  (This piece was actually added in the second bill, called the Health Care and Reconciliation Act of 2010.)  It will impact taxpayers with incomes greater than $200,000 (or $250,000 for people who are married).  This is a 3.8% tax on income from sources that are not from the ordinary course of trade or business.  There’s a long list of examples in the legislation (Section 1402 if you want to read it for yourself) but basically we’re talking about investment income here.   While I don’t expect to do many tax returns with a house that gets this tax, it is likely to create more taxes for people with investment income.  Call it a stock-tax or mutual-fund-tax and I’ll be nodding in agreement.

This is where the home issue comes up.  When you sell your primary residence, most people do not pay a capital gains tax on the sale. The reason is there is an exclusion  for the first $250,000 (for married people it’s $500,000) of profit on the sale.  That means if you sell a half million dollar home for $700,000 you don’t pay any taxes on the difference – even though you got $200,000 more than you paid for it.  Now let’s say you sell this same house for more than a million dollars.  You would have to pay capital gains tax on the amount of profit that exceeded your threshold for the exclusion.    You would pay the Medicare surcharge tax (the additional 3.8%) on the profit that was more than the exclusion amount, if the combination of that and your income adds up to more than $200,000 ($250,000 married).  OK I get that it’s confusing.  Clearly I should really reconsider my complaints about congress and taxes.  Without such convoluted provisions, being an accountant could get boring.