There are a variety of new taxes implemented by the Affordable Care Act (also known as Obamacare) that will affect 2013 tax returns, and the one most real estate professionals are asking about is the new 3.8% investment income tax. How much impact will it have on real estate investors?
The short answer: the 3.8% tax created by the Affordable Care Act will only affect more successful real estate investors, as the tax is only applied to investment income over $200,000 for individuals and $250,000 for married couples. Still, there are some complexities that deserve a closer look, and other Obamacare tax changes that will affect real estate investors and landlords as well.
First and foremost, the new 3.8% tax is not a real estate tax. It is a tax on a class of income referred to as “unearned” income, or more accurately as net investment income, which includes capital gains, net rental income, dividends and interest on savings or money market accounts. The tax is applied to the net investment income portion of adjusted gross income, over the first $200,000/$250,000 earned.
For a simplified example, Investor Ingrid is single and makes $150,000/year taxable income from her day-to-day work. This year she also decides to sell one of her investment properties for $200,000, and after paying off the mortgage and closing costs she walks away from the settlement table with net proceeds of $100,000. Ignoring the various deductions she has hopefully capitalized on, she has an adjusted gross income of $250,000, the last $50,000 of which she will owe the 3.8% new Obamacare tax on (3.8% of $50,000 = $1,900).
The new investment income tax is not the only new tax that will affect real estate investors. Last year, the Medicare tax (part of the FICA taxes) was 2.9% total (half paid by employers, half paid by employees, or all paid by self-employed individuals), and it has now risen to 3.8% for income over $200,000 for individuals and $250,000 for married couples. As most real estate investors are self-employed, they will be looking at paying the full rate themselves (a rise in FICA taxes from 15.3% to 16.2%).
A third tax change that will affect many real estate investors is the floor raise for medical expenses to be tax-deductible. Previously medical expenses had to be at least 7.5% of a filer’s income to be deductible, but for 2013 tax returns they must be at least 10% of income to be deductible as an expense.
Some unsolicited advice: make sure your accountant can competently discuss these new Obamacare tax changes with you, because the three above are only a few of the many tax changes taking effect this year. If they can’t answer questions about these, it’s time for a new accountant.