Real estate brokers who deal in high-end properties have been reporting an upsurge in listings. Some sellers are desperate to sell their homes before Jan. 1, 2013, when they could be subject to much higher tax rates on capital gains.
Are these sellers right to be worried?
The short answer is "yes," some sellers should be concerned about higher taxes on capital gains in 2013. If the Bush tax cuts are allowed to expire at the end of 2012, some taxpayers will see an increase of 8.8 percent on their taxes on long-term capital gains, including gains on home sales.
Currently, the maximum tax rate on long-term capital gains is 15 percent. If the Bush tax cuts expire, this will go up to 20 percent on Jan. 1, 2013.
Also on Jan. 1, the new Medicare tax enacted as part of Obamacare will take effect. This will impose a 3.8 percent tax on investment income of individuals earning more than $200,000 and couples earning more than $250,000. Together, these result in a 23.8 percent tax on long-term individual capital gains — an increase of 8.8 percentage points compared with the current 15 percent rate.
However, while the 20 percent capital gains rate would apply to all long-term capital gains, the 3.8 percent Medicare tax will, at most, apply only to the amount a taxpayer’s income exceeds the applicable income threshold ($200,000 or $250,000).
Moreover, homeowners will still be eligible for the $250,000/$500,000 exclusion on capital gains from home sales. This means that the 3.8 percent Medicare tax will affect relatively few homeowners. Nevertheless, it will be a hit on homeowners who have substantial equity and income.
For example, an individual with a $500,000 in income would have to pay the 3.8 percent tax on up to $300,000 of his investment income in 2013. If this individual owned a home with $750,000 in equity and qualified for the $250,000 exclusion, he would be left with $500,000 in investment income, $300,000 of which would be subject to the 3.8 percent tax — an additional tax of $11,400.
If the Bush tax cuts expired, this person would also have to pay an additional 5 percent in capital gains tax on his home sale profit (20 percent instead of 15 percent), which would result in $25,000 in additional tax.
Altogether, this luckless person would owe an additional $36,400 in taxes if he sold his home in 2013 instead of 2012.
Any person with substantial income and equity should perform this simple calculation to determine how much tax they could have to pay if they wait until 2013 to sell. They may well conclude that it is wise to sell before the end of the year.
Stephen Fishman is a tax expert, attorney and author who has published 18 books, including "Working for Yourself: Law & Taxes for Contractors, Freelancers and Consultants," "Deduct It," "Working as an Independent Contractor," and "Working with Independent Contractors." He welcomes your questions for this weekly column.