3.8% surtax on home sales is small deal for big earners

: Jul 18, 2012

The silly season of national politics landed in my email inbox last week. I might have ignored the item if a) it had nothing to do with real estate and b) if it wasn’t so deceptive in its implications for home sellers.

It all started when a Realtor I know received an email from a Realtor he knows that referenced a surtax of 3.8% in the Affordable Care Act (you may know it by its pejorative, ObamaCare). Reading mostly only the subject line, and missing its hysterical doomsday implications, my Realtor friend passed the message on to a couple

Small business owners don't think about taxation when they envision their businesses. Neither should home sellers.

of dozen others, mostly other Realtors. The email then caused a flurry of political comments, some of them vicious and stupid by one particular Realtor. I guess I started it by simply asking everyone on the list to read the entire article at Snopes.com, which typically does a good job of separating fact from rumor.

The original sender commented that Realtors would find it impossible to sell homes because people who wanted to sell their homes wouldn’t do so because of the onerous tax. Her naïve reading of the provision in the Affordable Care Act was that a “transfer tax” of 3.8% would be applied to the selling price of a home. In point of fact, that is nonsense; the tax is on investment income, not on the sale of the home.

Here is how the tax is applied. First of all, if you qualify for a $500,000 exclusion on profits in your home (for joint-filers, $250,000 for singles), then you still qualify for it. Second, the 3.8% is a surtax on investment income for couples earning more than $250,000 annually, not a transfer tax. Even then, such high earners will not be liable for the surtax if their income is “solely earned,” that is from salaries and other income from active participation in a business. Those who derive a sizable portion of their income from dividends, interest, capital gains and rental income may be subject to the surtax but, again, only after the $500,000 exclusion (for a married couple).

In short, the only folks who need worry about the 3.8% surtax are those who make in excess of a $500,000 profit on the sale of their homes and receive most of their other income from passive investments. Ken Harney, a real estate expert writing in the Hartford Courant’s real estate section last Sunday, gave the following example provided to him by the National Association of Realtors:

“Say you and your spouse have adjustable gross income of $325,000 and you sell your home at a $525,000 profit. Assuming you qualify, $500,000 of that gain is wiped off the slate for tax purposes. The additional $25,000 gain qualifies as net investment income under the health care law, giving you a revised AGI of $350,000. Since the law imposes the 3.8% surtax on the lesser of either the amount your revised AIG exceeds the $250,000 threshold for joint filers ($100,000 in this case) or the amount of your taxable gain ($25,000), you end up owing a surtax of $950 ($25,000 x .038).”

The current debate about taxes and their effect on both business and homeowners is silly. I can honestly say that I did not consider tax issues for one second when I conceived my small business, and neither did any of my small-business friends. Couples selling their homes in the near future shouldn’t think about the taxes either.