Here is my attempt to break down the American Taxpayer Relief Act of 2012 (signed into law January 2013) specifically for sellers of residential real estate. Note that I am not an accountant and everyone should consult an accountant or other qualified expert about their own situation.
First, does any of this really affect you?
A) Table to show when different taxes / limitations kick in based on your federal adjusted gross income (AGI):
|Your Federal AGI||Single||Married|
|$ 200,000||Medicare (UIMCT)|
|$ 250,000||PEP and Pease||Medicare (UIMCT)|
|$ 300,000||PEP and Pease|
|$ 400,000||Capital Gains|
|$ 450,000||Capital Gains|
|Medicare (UIMCT)||Unearned Income Medicare Contribution Tax (3.8%)|
|PEP and Pease||Personal Exemption Phaseout and Pease limitations on deductions|
|Capital Gains||Top Capital Gains Rate (20%)|
I believe with the exception of capital gains, the other items are not retroactive to the first dollar.
The UIMCT was not referenced in the Taxpayer Relief Act but I’m including it since it kicks in at the same time.
B) The Unearned Income Medicare Contribution Tax is part of Obama’s healthcare plan (PPACA) and is intended to make the wealthiest Americans help pay for the plan.
- Wages: All wage-earners must pay a 2.9% medicare payroll tax. Above $200,000 or $250,000 (single or married), there is an additional 0.9% (3.8% total).
- Investment Income: Above the same income thresholds, there is a 3.8% tax on net investment income which could include gains on real estate.
C) PEP and Pease are limits on personal exemptions and itemized deductions such as the mortgage interest tax deduction. The Taxpayer Relief Act of 2012 establishes thresholds of $250,000 and $300,000 for single and married filers, which will be adjusted for inflation moving forward.
- The Personal Exemption Phaseout (PEP) reduces personal exemptions ($3,800 in 2012) for both taxpayers and their dependents by 2 percent for each $2,500 (or part of $2,500) that adjusted gross income (AGI) exceeds the threshold for the relevant filing status. In an example of PEP, one article presents a taxpayer $22,000 over the threshold. His/her personal deductions of $3,850 are reduced by less than $700.
- The “Pease” Limitation on Itemized Deductions reduces most itemized deductions by 3 percent of the amount by which AGI exceeds a specified threshold, up to a maximum reduction of 80 percent of itemized deductions.
D) Capital Gains – Long term gains now top out at 20% for those earning more than $400,000 or $450,000 (single versus married). So on a primary residence, that would be net gains in excess of the standard exemption of $250,000 for single filers and $500,000 for married couples.
E) Estate Tax – Tops out at 40% and a $5 million exemption ($5.2mm to be exact?), which will be adjusted for inflation moving forward.
F) Income Taxes – Those earning more than $400,000 or $450,000 (single versus married) are now subject to a 39.5% Federal income tax rate. The payroll tax will increase from 4.2% to 6.2% which will impact most Americans.
There are other items in the Act but the aforementioned should cover the bulk of the items that broadly impact real estate owners and how much home you can afford. It was interesting that carried interest was not touched, a good thing for the hedge fund / private equity fund demographic.
The next question of course is what can you do, particularly if you are sort of in the middle bracket between those too ‘poor’ to be truly affected and too rich to avoid being affected?
Here are some ideas. Again, consult a tax expert:
- If you have significant gains on your residence you may want to consider selling, taking the exemption of $250,000 or $500,000 (single versus married), and purchasing a new home thereby resetting your cost basis.
- If you expect that your gains will significantly exceed the exemption, it might be worthwhile to look into a 1031 exchange. As I understand it, this involves renting out your property for two years which would qualify it as an investment property, and then selling it and purchasing a new “like-kind” investment property (a 1031 exchange) without triggering capital gains. Essentially you are deferring those taxes. Even if you live in a co-op, this might be a possibility. This can get a little complicated so definitely speak to a qualified expert who has firsthand experience.
- Get married! Okay, this is a mostly a joke, but if you are sitting on significant gains on your residence and you are in a serious relationship and maybe were thinking of popping the question anyway, here’s another incentive. Spend $25,000 on a ring and get an additional $250,000 exemption!
- Since AGI can be reduced by items such as business expenses and health savings accounts, it might be worthwhile to take full advantage of any applicable items that reduce AGI. For example, alimony payments apparently also reduce AGI, so after you get married and sell your home, you can get divorced and be generous…
- Take full advantage of exclusions from the calculation of certain tax liabilities, such as income from municipal bonds and retirement account distributions.
- If your estate is above or close to the $5 million exemption, you may want to consult an estate planner. Similarly, if you are in the highest income tax bracket you may want to move income producing assets out of your estate (ie: gifting to heirs in lower brackets).
Any other ideas?