Does Health Care Reform Include a Real Estate Tax?

Health care reform ain’t pretty and it ain’t cheap. (Of course, neither was America’s health care system before the passage of the Patient Protection and Affordable Care Act, but that’s not the point). Someone has to pay for the new law and there’s a host of fees, taxes and the like to foot the bill.

In a comment on my previous post, Jim Diani asked about a 3.8% tax on real estate sales the PPACA imposes starting in 2013. Since the answer concerns more than real estate transactions and hasn’t been discussed much here, I thought a post would be helpful.

There is no tax in the new health care reform aimed specifically at real estate transactions, yet there is a tax that will apply to many such sales. Specifically, the PPACA imposes an “Unearned Income Medicare Contribution tax of 3.8% imposed on the lesser of income over $200,000 for individuals (and $250,000 for joint filers) or on investment income.  This tax was contained in the reconciliation bill, HR 4872 (page 33 for those keeping track). Investment income , and more precisely, “net investment income,” is defined as the sum of “gross income from interest, dividends, annuities, royalties, and rents” not earned in the ordinary course of a trade or business and “net gain (to the extent taken into account in computing taxable income) attributable to the disposition of property,” but not property held in a trade or business.

(This seems like an appropriate point to mention that those seeking a formal interpretation of this provision of the PPACA should consult with your tax expert and that nothing in this post is intended to be or should be taken as tax or financial advice. While we’re at it: clean your room; don’t mix reds and whites in the laundry; if you’re a broker join NAHU;  and don’t text while driving. Now back to our regularly scheduled post.)

So how does this play out. For an individual earning a salary of $300,000 per year who sells her home for $800,000 which, after offsetting basis and various homeowner deductions nets her a profit of $250,000 on the sale, the tax would apply to the $100,000 in salary above the $200,000 threshold (for an additional tax of $3,800) and nothing on the $250,000 unearned income netted from the sale of the property. Change her salary to $500,000 and, since the tax applies to the lesser of wages above the threshold or unearned income, she’d pay an additional $9,500 of taxes on the sale of the house. (Note 11/11/10: This example has changed from the original posting thanks to an error pointed out by reader Don H . Thanks Don for this catch and to Janet Paiwelson for noting the typo on the Medicare Part A tax, below — which has also been correct. I apreciate the help from both of you).

Whether the tax applies to the sale of a home, then, depends on several factors. Clearly the tax is not applied on the total sales price (in the example above, the $800,000). Many taxpayers realize little income from home sales thanks to the tax-favored nature of this particular investment.  But to the extent there is some taxable income realized from the sale of a home under today’s tax code, the PPACA does apply a 3.8% on this investment income to help fund Medicare.

And to be clear, the tax isn’t targeted at home sales. It applies to a broad range of unearned income.

Ask supporters why they imposed this tax and the most common answer will be that it’s a matter of fiscal responsibility (President Barack Obama insisted that the new health care reform law be deficit neutral) and as a matter of tax equity. This latter point goes to the current situation in which only salaries and wages are subject to the Medicare tax. There’s a whole group of Americans who earn hundreds of thousands of dollars on investments, dividends and the like who avoid this tax yet benefit from Medicare. Imposing this tax on non-wage income is viewed as a way of making the tax system more fair.

Incidentally, this isn’t the only new Medicare tax. Individuals making at least $200,000 a year or married couples earning $250,000 will see their Medicare Part A taxes increased by 0.9%. Taken together, this increase and the Unearned Income Medicare Contribution are expected to generate $210 billion between 2013 and 2019.

The new Congress may try to eliminate or postpone these taxes, but my guess is they’ll have a tough time doing so. First, because politically it’ll be hard for Republicans to constantly be seeking tax relief for high wage earners and those living on investments. Second, the expected revenue from these taxes amounts to over 20% of the cost of health care reform. Reducing or eliminating this revenue would gut the PPACA and President Obama won’t agree to that.

Meanwhile, back at the original question: does the new health care reform impose a 3.8% tax on the sale of homes? Only to the extent any portion of the sales price would be considered taxable income today and that income (when combined with other investment income) exceeds the taxpayers wages above $200,000 for an individual and $250,000 for a couple.

Thanks for the question, Jim. Hope this helps.