(The writer is a Reuters columnist. The opinions expressed are her own.)
By Amy Feldman
NEW YORK Oct 15 New 2013 taxes aimed at high earners could hurt some less-wealthy folks who sell valuable real estate without planning ahead.
That's because the income from the sale of a pricey home or investment property could push taxpayers into a higher tax bracket at a time when rates for those top brackets are going up.
The new top marginal income tax rate is 39.6 percent for single taxpayers earning over $400,000 and married couples earning over $450,000. There's also a new Medicare surtax of 0.9 percent on earned income (on top of the existing 1.45 percent Medicare payroll tax on all income) and a 3.8 percent tax on net investment income, both of which kick in when earnings top $250,000 for married couples and $200,000 for singles.
The 3.8 percent tax applies to the lesser of your net investment income or the amount it puts you over the threshold. For long-time homeowners - who hoped to use the proceeds from selling their homes to fund retirement - that could be a rude awakening. People who own investment real estate may also get hit, but they have other planning options.
Here's what the new tax landscape for real estate looks like and how to avoid being taxed like the rich if you're not, but still getting ready to sell your home.
SELLING A PRIMARY HOME
When you sell your primary home, you benefit from a tax exclusion: Unless your gain tops $500,000 for married taxpayers filing jointly or $250,000 for single filers, you owe nothing.
If your gain is above that amount - as might be the case if you bought years ago in a pricey market like New York or San Francisco - you'll owe capital gains taxes of 15 percent on the amount that's over that level (or 20 percent if you're in the top tax bracket).
That taxable portion of the sale could push you over the threshold for the extra 3.8 percent tax on investment income.
The calculations can get complex, but here is a simple version: Say a married couple bought a home 10 years ago for $700,000 and sold it recently for $1.3 million, logging a $600,000 gain. (To keep it simple, ignore home improvements and other factors that affect calculations.) After exempting $500,000, they'd have a $100,000 gain and owe $15,000 capital-gains tax on that sale.
If that $100,000 gain pushes the couple's adjusted gross income to $300,000, they would owe an extra $1,900 in taxes, because they would have to pay the 3.8 percent tax on the $50,000 that their income is over the $250,000 threshold. They wouldn't owe the tax on the remainder of their investment income.
One way to lower the tax hit is to time your sale to stay below the threshold. If you're nearing retirement, you might wait to sell until your income is lower. Or if you're a consultant or business owner with variable income, you might opt to sell in a lower-income year.
Another option: an installment sale, in which you sell the property in steps. If you receive half the sale price this year, and half next, you may be able to smooth your income between the two tax years to stay under the threshold.
SECOND HOME BLUES
The higher tax could have a larger impact on people who own vacation homes or rental property - they cannot take advantage of the big exclusion for sale of a primary home.
Owners of investment properties get to reap tax savings by deducting depreciation each year. But when they sell they have to "recapture" the value they wrote off and pay a 25 percent tax on it. For example, a landlord who bought a house for $700,000, wrote off $150,000 in depreciation, and then sold it for $1.3 million would have a total gain of $750,000. But that gain includes two pieces at different rates: $600,000 at the 15 percent capital gains rate, and the $150,000 depreciation recapture at 25 percent, for $127,500 in tax. What about the 3.8 percent tax? If we assume the landlord is single and has $100,000 in other income, he's now over the threshold by $650,000, meaning an extra $24,700 in tax - as would be the case if the gain came from other investments.
Of course, that landlord already benefited by depreciating his property against income over the years, at a tax rate likely above 25 percent.
In addition, those with investment property may be able to postpone paying taxes with what's known as a like-kind exchange. In such a deal, one piece of real estate is swapped for another "like-kind" one (residential real estate, for example, cannot be swapped for unimproved land). That may let you defer taxes until you sell the final property in the chain.
An intriguing way for real estate investors to avoid the new 3.8 percent tax is to claim status as a real estate professional. This lets you exclude rental income from the net investment income calculations.
"If you are a professional, you can carve real estate out of the Medicare tax entirely," says Ken Weissenberg, a tax partner and leader of the real estate services group at accounting firm EisnerAmper.
The line between personal and professional isn't always clear, but property owners, brokers and developers who spend at least 750 hours a year on real estate could qualify. Some retirees and consultants who spend a high percentage of their time on real estate activities may be able to go pro, and Weissenberg says he has some clients who are putting more time into their real estate dealings so they can qualify. (Follow us @ReutersMoney or here; Editing by Linda Stern and Dan Grebler)