The National Association of Home Builders had this to say on the subject...
False rumors are circulating the Internet that the new 3.8% Medicare tax on so-called unearned income set to take effect in 2013 is a direct tax on the sale of a home.
This is not the case.
The tax increase on capital income – such as capital gain and rents – will affect some real estate investments. However, it should have a negligible impact on home owners selling their principal residence.
The 3.8% Medicare tax is one of the provisions in the Affordable Care Act, also known as “Obamacare,” that was enacted in 2010. The tax will affect high-income taxpayers who report taxable income due to capital gains and other non-wage income. It will not affect income that is currently tax-exempt, including most capital gain due to the sale of a principal residence which is exempt due to the $250,000/$500,000 gain exclusion rules.
The tax increase could affect a small percentage of home sales, such as second homes that are not subject to the gains exclusion or sales that involve a significant capital gain. However, the number of transactions impacted by the new tax would be further limited because taxpayers with less than $250,000 in income are not subject to the tax.
Impact on Rental Income
The 3.8% Medicare tax will affect high-income taxpayers who report taxable income due to capital gains and other investment income. Net investment income is the sum of income from interest, dividends, annuities, royalties, rents and capital gain.
The IRS released proposed regulations and an FAQ on Nov. 30 which confirms that all active net rental income derived from active participation in a trade or business is exempt from the new tax. This is a positive development.
However, net rental income due to passive participation (in which the investor puts in money but has no material participation or management authority) is subject to the 3.8% tax.
How is the Tax Calculated?
Here are two examples:
- Suppose a couple has wage income of $260,000 and $9,000 in capital gains. The extra 3.8% tax applies to the lesser of $19,000 (the difference between their total income of $269,000 and the $250,000 threshold) and $9,000. $9,000 is the lower amount, so the increased tax is equal to $342 ($9,000 times 3.8%).
- Suppose a couple has wage income of $50,000 and gains income of $210,000. The extra 3.8% tax applies to the smaller of $10,000 (the difference between their total income of $260,000 and the $250,000 income threshold) and $210,000. $10,000 is lower, so the increased tax is equal to $380 ($10,000 times 3.8%).