The Facts about Medicare Contribution Tax on Unearned Income and the "Home Sale" Exclusion
There has been a great deal of misunderstanding and misinformation circulating with regards to elements of the health care reform legislation passed in 2010. In particular, there has been a rash of internet stories and chain emails purporting that the legislation includes a 3.8% “real estate tax” that would apply to the sale of a principal residence. Although there have been no changes to the rules for excluding a substantial amount of the gain on the sale of a principal residence, the act does include tax on net investment income that can apply to the taxable portion of a home sale for some taxpayers.
Beginning in 2013, taxpayers with modified adjusted gross income (MAGI) in excess of $200,000, $250,000 for married taxpayers filing jointly, will be subject to a 3.8% tax on the lesser of their “net investment income” or the amount by which their MAGI exceeds the threshold amount. Net gain from the disposition of property not held as part of an active trade or business is included in determining “net investment income” along with interest, dividends, annuities, royalties and rents.
However, for most taxpayers the gain on the sale of their principal residence will be partially or fully excluded from income tax and as such, not includable in determining net investment income for the purposes of the Medicare contribution tax. Gain on the sale of a principal residence is only taxable to the extent that the gain exceeds $250,000 or $500,000 for married taxpayers filing a joint return. A recent Journal of Accountancy Article included this excellent example of how the Medicare contribution tax may apply to a typical home sale scenario.
A married couple with MAGI of $325,000 purchased a home in California many years ago for $350,000 and sold it this year for $900,000, realizing a gain of $550,000. After excluding $500,000 gain under Sec. 121, they are left with $50,000 investment income (assume they have no other investment income). Since their AGI is $75,000 over the tax’s threshold amount for married taxpayers filing jointly, the lesser amount of $50,000 would be subject to taxation. At 3.8% they would owe $1,900.