MEDICARE TAX AND GENERAL CAPITAL GAIN TAX UPDATE
About a year ago, I wrote this: "Remember
right about this time two years ago when Congress was fighting about whether to
extend the Bush tax rates? Well... it's déjà-vu all over again!" Well guess what--it's déjà-vu
all over again again (with a few variations).
As things currently stand, there is a myriad of tax rate changes that are
on the horizon unless Congress takes some action. This article will deal primarily
with only one change, commonly referred to as the "Medicare tax," that may h
an impact on taxpayer
s involved in Section 1031
exchanges. (If you are
interested in details about the Medicare tax, please read to the end. There is
a link to a great brochure that the National Association of REALTORS® has made
The impending sunset of the Bush tax rates
at the end of 2012 will result in an increase in the federal capital gain tax rate
from its present 15% to 20%. Congress is currently grappling with whether to
extend the present rates, including the capital gain rate, for all taxpayers
(as the Republican-controlled House of Representatives has voted) or to extend
the rates only for those whose income is $250,000 or less (as the Senate's
version puts forth). I will spare you my
editorial comment on the issue, but I will give you this opinion-it is unlikely
that this impasse will be resolved prior to the November 6 election because of
two things. First, at the end of this week, Congress will take their normal
five-week recess. Second, when they return there will be only three weeks
before the election. Chances are strong that Congress will be occupied with
passing a stop-gap funding measure to avoid a government shutdown after the
September 30 end of the fiscal year, since they haven't passed a budget for
over three years. (Subtle editorial comment contained in that last phrase-did
you pick up on it?)
What I really want you to consider is the
new tax commonly called the Medicare tax. This is a 3.8 percent tax that will
be imposed on some investment income, ostensibly to help fund President Obama's
health care plan and Medicare overhaul. While it will not be imposed on all real
estate transactions, it will apply to individuals with an adjusted gross
income (AGI) above $200,000 and couples with greater than $250,000 AGI. The key
here is that AGI includes income from capital gains.
Here's an example of a situation that is
fairly common among our clients. Joe is single. He inherited a farm in 2002
from his parents. At the time of the inheritance, the farm's value was
$325,000, which is Joe's basis in the property. Joe's other income will have an
effect on these calculations, but for simplicity we will assume that he has no
other income. Joe sells the farm for $1.2 million and the closing is set for
after January 1, 2013.
new "Medicare tax" applies as follows:
Gain on Sale $875,000 ($1.2 million - $325,000)
Adjusted Gross Income (AGI) $875,000 (Gain + no other
Excess AGI over $200,000 $675,000 (Subject to 3.8% tax)
Medicare Tax Due $ 25,650 ($675,000 x 0.038%)
Capital Gain Tax Due $175,000 ($875,000 x 20%)
Total Tax Due on Sale $200,650 ($175,000 + $25,650)
Compare to Current Tax Rate $131,250 ($875,000 x 15%; no
Additional Tax Under New $ 69,400 ($200,650 - $131,250)
Compared to selling in 2012, Joe's tax is
52.9% higher because he sells in 2013.
One interesting thing about this new 3.8%
tax is that it is unresolved whether it can be deferred through the use of a
like-kind exchange. In general, most of us who work in the exchange industry
believe the tax should be able to be deferred, but the question has not been
addressed in regulations to date.
of today (8/1/2012), there are three primary possible tax outcomes to real property sales beginning
January 1, 2013:
Congress extends the Bush-era tax rates
top federal tax rate on long-term capital gains will increase from 15% to
18.8% (15% capital gain tax plus the new 3.8% Medicare tax).
Congress lets the Bush-era tax rates expire
the top federal tax rate on long-term capital gains will increase from 15%
to 23.8% (20% capital gain tax plus the new 3.8% Medicare tax). By the way, the top tax rate on dividends will nearly triple to 43.4%.
Congress extends the Bush-era tax rates, but not for all tax brackets
we will face a combination of the above two scenarios. The top federal tax
rate on long-term capital gains will likely rise for higher income
taxpayers, but remain at current levels for lower earners. In either case, though, the new 3.8% Medicare tax will come into play if it is applicable due to the taxpayer's adjusted gross income.
Remember, the 3.8% Medicare tax increase is a done deal and will
apply regardless of whether current tax rates are extended or not. For a more
detailed overview of this new tax, including several examples, please see this
brochure produced by the
National Association of REALTORS®.
Owners of real
estate, particularly those who own farmland or investment property, should
consult with their advisors to determine whether this tax may affect
them. This article does not cover every instance where the tax may be due
and Iowa Equity Exchange cannot give tax or legal advice.
If you are selling your property and would like to discuss the pros and cons of
a Section 1031 tax-deferred exchange, please contact Iowa Equity Exchange.
IOWA EQUITY EXCHANGE