The 2013 3.8% Tax

Starting January 1, 2013, a 3.8% tax on some investment income will take effect.  This tax will affect some, but not all, real estate transactions.  When the tax goes into effect two years from now, it MAY impose a 3.8% tax on some interest income, dividends, rental income (less expenses) and capital gains (less capital losses).  The tax will apply only to those individuals with an adjusted gross income (AGI) above $200,000 and couples filing a joint return with an AGI of more than $250,000.  The new tax would apply to the lesser of the investment income amount or the excess of AGI over the $200,000 or $250,000 amount.

The National Association of Realtors provides the following examples of the how tax will work in certain common situations:

Example 1:  Capital Gain Sale of a Principal Residence

John and Mary sold their principal residence and realized a gain of $525,000.00.  They have an AGI of $325,000.00 (before adding taxable gain).

The tax applies as follows:

AGI before taxable gain:                       $325,000

Gain on sale of residence:                    $525,000
Taxable Gain (added to AGI):               $25,000 ($525,000-$500,000)
New AGI:                                            $350,000 ($325,000+$25,000)

Excess of AGI over $250,000:              $100,000 ($350,000-$250,000)
Lesser Amount (table):                         $25,000.00

Tax Due:                                              $950.00 ($25,000x0.038)

* If John and Mary 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% tax.  Whether they paid the 3.8% tax would depend on other components of their AGI.

Example 2:  Income Sources Including Real Estate Investment Income

Hank has a "day job" from which he earns $85,000 a year.  He owns several small apartment units and receives gross rents of $130,000.  He also has expenses related to that income.

The tax applies as follows:

AGI Before Rents:                              $85,000

Gross Rents:                                       $130,000
Expenses (appreciation; debt service):  $110,000
Net Rents:                                           $20,000
New AGI:                                            $105,000 ($85,000+net rents)

Excess of AGI over $200,000:             $0
Lesser Amount (table):                        $0

Tax Due:                                             $0

* Even if Hank's combined gross rents and day job earnings exceed $200,000, he would not be subject to the 3.8% tax because his investment income includes net, not gross, rents.