New real estate taxes bring wave of confusion

During the recent spring break, we visited with family and friends who were considering real estate purchases and sales.

One couple were selling their primary residence, a modest brick Tudor in an established suburban neighborhood, and buying a “maintenance free” condominium downtown. Another couple, their three children now grown and gone, were looking for a smaller home nearby where they could grow vegetables and flowers. Gardening is their passion. A brother-in-law, a retired stockbroker who now monitors and conducts his trades from home, said he was planning to sell his split-level home in the next two years because “all real estate would be taxed more in 2013.”

He is not alone in his thinking. The truth, however, is that only a small percentage of home sellers will pay the new 3.8 percent tax on some investment income that will take effect in January 2013. The new tax will not apply to a vast majority of the population. The new tax was passed by Congress last year with the intent of generating an estimated $210 billion to help fund President Obama’s health care and Medicare plans.

“The health care plan could be repealed or changed in some way, and the 3.8 percent tax is certainly a part of that plan,” said Rob Keasal, a real estate tax specialist. “If it does, I think we can all expect a similar tax to take its place.”

In reality, only those taxpayers with incomes over $200,000 a year ($250,000 for married couples filing jointly) will be subject to the new tax. And even for those who have high incomes, the tax still won’t apply to the first $250,000 on profits from the sale of a personal residence – or to the first $500,000 in the case of a married couple selling their home. The entire exemption on the sale of a primary residence remains intact and can be claimed every two years.

Also, gain is a net number. It is not the simply the difference between the original purchase price and the eventual sales price. Homeowners can subtract real estate commissions, excise tax and capital improvements before arriving at a net figure for capital gains purposes.

According to the National Association of Realtors, the median home price for the past 12 months was $193,200 in the West, $136,600 in the South, $126,300 in the Midwest and $236,500 in the Northeast.

“What we know for sure is that the long-term capital gains rate will remain at 15 percent for 2011 and 2012,” Keasal said. “For 2013, it could go back up to 20 percent or be changed again completely. But, as of right now, higher income people with second homes who are considering selling would be better off selling before 2013 because there’s no exemption.”

Here are a couple of examples of the 3.8 percent tax for higher income homeowners in 2013:

Capital gain: Sale of a principal residence: Joe and Sally owned their home for 30 years and then sold it, realizing a $525,000 gain. They have $325,000 Adjusted Gross Income (AGI) before adding taxable gain on the house. The tax applies as follows:

AGI before taxable gain: $325,000

Gain on sale of residence: $525,000

Taxable gain $25,000 ($525,000 minus $500,000) added to AGI

New AGI: $350,000 ($325,000 plus $25,000 taxable gain)

Excess of AGI over $250,000 minus $100,000 ($350,000 minus $250,000)

Lesser amount (home sale excess taxable) $25,000 (taxable gain)

New 2013 tax due: $950 ($25,000 times 0.038)

Since the new tax applies to the lesser of (a) investment income amount, (b) excess of AGI over the $200,000 or (c) home-sale exemption amount ($500,000 for married couples), Joe and Sally would pay $950 of new tax in addition to the capital gain on $25,000. If Joe and Sally had a gain of less than $500,000 on the sale of their residence, none of that gain would be subject to the 3.8 percent tax. Whether they paid the 3.8 percent tax would depend on the other components of their $325,000 AGI.

Sale of a second home (with no rental income more than 14 days): The Olsens own a lakefront home that they purchased for $275,000. They have never rented it to others, except to other lake neighbors for weekend family reunions. Their annual rental days have always been fewer than 14 days. They sell it for $335,000. In the year of sale they also have earned income from other sources of $225,000. The 3.8 percent 2013 tax would apply as follows:

Income from other sources: $225,000

New AGI: $285,000 ($60,000 plus $225,000)

Excess of AGI over $250,000 minus $35,000 ($285,000 minus $250,000)

Capital gain: $60,000

Lesser amount: $35,000 (AGI excess less than second home capital gain)

Tax due: $1,330 ($35,000 times 0.038)

Remember that any new tax on real estate will be for higher income individuals and this is not scheduled to take hold until 2013. Since three major tax changes occurred in 2010, expect more changes before 2013.