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New 3.8% Tax on Home Sales to Start Jan. 1

Updated on September 24, 2012

Bad Information

Have you heard the rumors about the new 3.8% tax on home sales? There are all sorts of rumors going around about it. Some of the ideas out there are close to the truth and others, not so much. Here are some of the horrific stories you may have heard that are going around...

  • Everyone will pay a 3.8% tax when they sell their home
  • You pay the tax only if you are rich
  • 3.8% levy is only paid if you don't buy another home
  • You pay the tax only if you live on a corner lot, in a green house, and drive a BMW

Of course, none of these rumors are true...although we chuckle each time we read the last one.

What is the Tax for?

This is part of the health care legislation that was approved in 2010. The tax is designed to generate $210 billion to fund health care reform. With this kind of money involved, it must apply to a pretty large portion of the population...right? Not necessarily. Let's take a look at who will be paying the tax and when.

Just the Facts

First, the tax is scheduled to go into effect January 1st. So, if you plan on selling a home anytime soon, you should carefully review the details to see if you are affected. If so, you may want to move up your listing date.

So what does the tax apply to? It applies to unearned income in the form of home sale profits, rental income, and investments. Here we will only be focusing on home sale profits.

The tax may only be applied to home sale profits, not the entire sale price. So you must first sell your home and then, you must make a profit. And as we all know, this can be challenging with the recent real estate recession. However if you have owned your home for a decade or more, you may have enough profit to be a candidate.

In addition, the tax will only apply to single people making more than $200k per year and married people making $250k or more. Keep in mind, the money earned from the sale may be added to your income under certain circumstances so keep reading.

The capital gains tax exclusion passed by federal law in 1997 will still apply to the sale of your primary residence. So, you will not pay the additional 3.8% tax on the sale of your home if both of the following are true...

  • it was your primary residence and you lived there for two of the past five years
  • you are single and your capital gain was $250k or less or you are married and your capital gain was $500k or less

This is somewhat complicated so let's take a look at an example.

An Example

So, let's say you're single, it's January and you just sold your house for $400k. We will also assume the following...

  • You originally paid $88k for the house in 1970
  • You made improvements totalling $5k over the years
  • Your selling expenses were $7k

So, your net capital gain would be $300k ($400k - $88k - $5k - $7k). So because of the federal law mentioned above passed in 1997, you wouldn't pay any tax on the first $250k as a single person. However, you may be required to pay the 3.8% on the remaining $50k gain. To find out how much tax you will pay, we need to add the $50k to your AGI (adjusted gross income). If the these two numbers combined exceeds $200k, then you would owe tax on whichever of the following is less...

  • $50k
  • the amount that your AGI exceeds $200k (remember you are single)

Now, let's say your AGI is $75k without including the home sale and $125k with it. You wouldn't need to pay the new 3.8% tax If your AGI was $275k with the house sale included, you would pay the 3.8% tax on the $50k because it is less.

Decision Time

If you think you will be affected by this tax, you may want to think about listing your property. A tax of 3.8% on a big gain on the sale of your home could get expensive. On the other hand, as most good investment gurus will tell you, don't make investment decisions based on tax consequences alone.

Is This a Good Idea?

Do you think the tax is a good idea?

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