How will the new Medicated Tax apply to real estate transactions? The health care legislation that passed in 2010 provided for a 3.8% surtax on many forms of investment income or “unearned income” such as interest, dividends, interest, rents and capital gains which will take effect in 2013. It is not a sales tax and it won’t apply in lager part to primary residence home sales that are excluded from income under current tax codes. However, the effect is focused on those individuals that have gains from the sale of vacation homes or investment properties.

The new surtax will affect individuals with more than $200,000 in adjusted gross income (AGI), and married couples with an AGI above $250,000 ($125,000 for married taxpayers filing separately). Specifically, the surtax will apply to either your net investment income or the amount that your AGI exceeds the threshold – whichever is less. For example, let’s say that a couple who has an AGI of $225,000 has sold a vacation home for a gain of $60,000. The gain increases their AGI to $285,000 ($225,000 + $60,000 = $285,000). Their threshold is $250,000, so their tax will be calculated on $35,000 ($285,000 – $250,000 = $35,000).

Rules applying the surtax become more complex concerning investment (property) income. If you own a vacation property solely as a rental property, it is treated as an investment property for tax purposes. Let’s say that you have a regular job and collect rents on the side. You must include that income (net of expenses) as investment income which could potentially subject that income to the surtax. On the other hand, if your sole occupation involves owning and operating the rental property for income purposes you would not be subject to the tax.

Additionally, application of the tax will depend on whether the vacation home has been rented out, the period for which it has been rented and whether the property is solely for the enjoyment of the owner. If the owner has rented the home out to others, then the 14-day rent exclusion will continue to apply. Thus, if the owner rents the property to others (including family members) for 14 or fewer days, there would be no net investment tax. (Note that no deductions for expenses would be available, as under current law.) 

If the home has been rented to others (including family members) for more than 14 days, then the rents (minus related expenses) would be considered as part of net investment income and could, depending on AGI be subject to the new tax. 

If the vacation home has been used solely for personal enjoyment (i.e., there is no rental income and no associated expenses), then a gain on sale would be treated as net investment income and could be subject to the tax, depending on AGI. Similarly, if the property had generated rents, any net gain on sale could also be included in net investment income.

Determining whether you will be subject to the surtax is no easy matter.

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