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

Summer season is almost officially over and wow, what a summer! I’ve had a lot change in my life. What about you? Any life changing events? New relationships? New job? A new house to call home?

My husband and I are finally moved into our new home in the southeast corner of Denver, in the Hutchinson Hills neighborhood. We are not close to being done unpacking at all, but we are enjoying the process of setting up shop! I think Stella enjoys it too; she’s free to roam a huge yard and scare off the bunny rabbits that find their way into our yard… poor bunnies! School is back in session, the days are getting shorter and I welcome the change of season. That’s one of the reasons I love Colorado, when you’re tired of one season it’s already time to move on to the next. Another thing I love about our new house, it’s less than 5 minutes to my office, Perry & Company – a huge plus for this gal.

This week I’m sharing information about the widely popular and heavily questioned sales tax on real estate. I hope to give you some background on the new law and answer the big questions. If you’d like to learn more, please contact me or your real estate or tax attorney!

Beginning January 1, 2013, a new 3.8 percent tax on some investment income will take effect. This new law, passed by Congress in 2010 with the intent of generating an estimated $210 billion could be relevant to you. Understand that this tax WILL NOT be imposed on all real estate transactions, a common misconception. Rather, when the legislation becomes effective in 2013, it may impose a 3.8% tax on some (but not all) income from interest, dividends, rents (less expenses) and capital gains (less capital losses). The tax will fall only on individuals with an adjusted gross income (AGI) above $200,000 and couples filing a joint return with more than $250,000 AGI.

Here are the Top 10 Things You Need to Know…

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 as 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 at settlement when you sell your home or investment property. Any capital gain you realize at 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 than these amounts, then you will include any gain above these amounts as income on 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 2013, 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 income.

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 $1000.

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 possibly 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.

This information has been provided by the National Association of Realtors.

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