Will you be paying sales tax on the sale of your home?

A rumor has been circulating for a while now that the gain on the sale of your home will soon be subject to a federal sales tax of 3.8 percent.  This story is indeed a rumor and started by someone who didn't have all of their facts straight and most likely doesn't understand taxes.  The rumor has spread quickly with the abundance of social media and other means.

It is true that some gain may be affected by an additional tax of 3.8 percent, but it clearly is not a sales tax and does not affect the gross proceeds.  It is actually part of the Health Care Law passed in 2010.  It is called the Unearned Income Medicare Contribution Tax and is imposed on individuals, estates and trusts and will also be imposed on some individuals investment income.  It is calculated as the lesser of:

1. The taxpayer’s net investment income or
2. The excess of modified adjusted gross income over the threshold amount ($250,000 for a joint return or surviving spouse, $125,000 for a married individual filing a separate return, and $200,000 for all others).

Why does this affect home sales?  Well, if you have any profit remaining from the sale after the reduction of the cost basis and also taking the $250,000 gain exclusion ($500,000 for married couples) that gain is considered investment income.  The gain exclusion is limited to those individuals who own and occupy as their primary residence for 2 of the last 5 years.

  Example – Joe and Dianne sell their home in 2013 for $600,000. They purchased that home 40 years ago for $50,000. For simplicity, let’s assume they made no improvements to the home and had no selling costs. Thus, they have a $550,000 gain. After they subtract the $500,000 home sale exclusion they end up with a taxable gain of $50,000. Their other gross income for the year is $75,000 (all earned income), for a total modified adjusted gross income (MAGI) of $125,000. Since the $125,000 is less than the $250,000 threshold for the surtax, they have no surtax. However if their other income (none of which is investment income) was $210,000, they would end up with a MAGI of $260,000. That is $10,000 over the $250,000 threshold for joint filers, and results in a surtax of $380 (3.8 percent of $10,000), which is less than the $1,900 surtax figured on their investment income from the net home sale gain of $50,000. Therefore, Joe and Dianne’s additional Medicare contribution tax is $380.

So the surtax will affect only those individuals in higher tax brackets.  If you have any questions feel free to contact me.