3.8% Tax on Investment Income, a Real Estate Transfer Tax? If it looks Like a Duck………….
By Victor Normand
Published: December 2010
An eleventh hour add-on to the healthcare reform legislation imposes a 3.8% tax on investment income. Realtor® Magazine recently ran an article claiming that such a tax was not a real estate transfer tax. Granted it is not a tax paid at closing like states impose, but in every other way it is a tax paid by many for the privilege of transferring real estate. Real estate sales has always been in the cross hairs of lawmakers looking to raise taxes and carving exemptions on lower incomes seems to soften the blow, but let’s be honest, a significant portion of investment income for many people involves real estate, and a tax that will raise $325 billion over eight years will have an impact on many individuals and families.
True, the exemptions for our individual residences will shield some taxpayers’ form this tax, but other real estate investments are exposed to the tax and often in a not so insignificant way. Planning for retirement for many involves the purchase of investment income property with the intention of holding on to the asset, using rental income to pay down debt and timing the sale to coincide with college expenses or retirement.
So, as is often the case, people with otherwise modest incomes will have a windfall, probably the only one in their lifetimes when they cash in on investment property. Over many years they have held on to and often managed and maintained the property themselves; now they will face an unplanned tax bill when they cash out. For example, a couple with adjusted gross income of $120,000 sells their fully depreciated rental property for $750,000. This may represent the bulk of their lifetime savings, which had been their plan all along. After the closing, when doing their taxes for the year they find an additional tax (not called a transfer tax, but it might as well be) of $23,560. ($120,000 AGI plus $750,000 gain, less the personal exemption of $250,000 for the couple, leaving $620,000 exposed to the 3.8% tax).
That’s the way it is with most taxes, they seem like a small amount and seem not to affect very many taxpayers, but they end up hitting more ordinary middleclass taxpayers then anyone realized. So, if you are in this situation and fortunate enough to be approaching the time to sell, you have a grace period. The tax does not take effect until 2013. Time your sale accordingly to avoid this Transfer Tax