The Patient Protection and Affordable Care Act created a new 3.8% Medicare tax

27 Oct The Patient Protection and Affordable Care Act created a new 3.8% Medicare tax

The Patient Protection and Affordable Care Act created a new §1411, which is effective for tax years beginning after December 31, 2012. This section will impose on high-income households a 3.8% Medicare tax on the lesser of “net investment income” or the excess of modified adjusted gross income over a “threshold amount” (generally $250,000 for taxpayers filing a joint return, $125,000 for married taxpayers filing separate returns, and $200,000 in all other cases).  Net investment income is the excess of

• interest, dividends, annuities, royalties, rents, income from passive activities, income from trading financial instruments and commodities, and gain from the disposition of certain non-business property over

• allowable deductions properly allocable to such income. In determining the amount of net investment income, special rules apply to dispositions of interests in partnerships and S corporations, and distributions from certain qualified plans.

Example: A married couple has lived in their home for two of the last five years, so when they sell the home they qualify for the $500,000 §121 capital gains exclusion. If their gain on the sale is less than $500,000, no part of the gain is subject to the §1411 tax. Likewise, if their gain on the sale is more than $500,000, but that gain, minus the §121 exclusion, plus their other income, gives them a modified adjusted gross income of less than $250,000, no part of the gain is subject to the §1411 tax. They will only be subject to the 3.8% tax on the gain if they have a combined income of over $250,000and their profit on the sale was more than the §121 exclusion.

The §1411 Medicare tax is not a sales tax that applies to all real estate transactions. It is a tax on investment income that could result in some high-income home sellers paying additional tax on home sale profit over a threshold amount.