Are You Prepared For The ‘Obamacare’ Real Estate Investment Tax?

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“Chris, are you prepared for the Obamacare real estate investing tax”?

That was a real question I was asked two weekends ago when I was in San Diego speaking to 450 active real estate investors.  From the concerned look on the face of the woman asking the question, apparently she was serious!

Up to that point, I was more concerned as a small business owner, and a successful one at that, about the effects of the health care law and was following closely the Supreme Court announcement simply to be prepared on what steps to take next.  When the question came up, I answered the lady that I had no idea how health care was going to affect me as a real estate investor and I had not given it one thought to that point.  I was much more concerned with concrete matters like avoiding cost overruns, delays in projects, vacant properties, uncollected rents, pending evictions, etc, etc…  You know – I told her to focus on what she was at the conference for and learn – not fret over a non-existent tax!

That night I decided to Google the lady’s question and see if it had any merit – and here is the answer I came up with.

Is There A Tax On Real Estate Investment In Obamacare?

Yes.  And No.  As grey as that sounds, the truth is actual very black and white.  Before I explain, I will tell you that worrying about it is best left to investors that like to worry.  Not worrying about it is best left to investors that like to make money.

In the healthcare bill, there is a new tax created on investment income for high income households and it is called a 3.8% medicare tax.  This tax will not affect all investment income and will not affect all real estate transactions.  It is not a sales tax, but a levy tax against profit on certain transactions that meet a high threshold.

What Are The Parameters Of The New Real Estate Tax?

First of all, it is a tax that will only be imposed on households with a combined income above $250,000 or individuals with an income above $200,000.  Regardless of the transaction, this is the first stipulation that must be met and excludes about 97% of all U.S. households.  From there, well you definitely get penalized for making good business decisions!

The next stipulation is that you must make a return on the sale of the investment property above the capital gains threshold which is $250,000 for individuals and $500,000 for couples.  That is a high threshold.  At that point the tax does kick in, but only applies to the amount of income above the exclusion.  For instance, if you sell a property and earn a $550,000 return as a couple, you will be subject to a 3.8% tax on $50,000 provided your adjusted gross income is above $250,000 for the year.  If not, then there is no tax.

Why Is The Medicare 3.8% Tax on Investment Income Even In The Health Care Bill?

Beats the heck out of me!  In the grand scheme of things, this particular provision promises to raise a very, very small amount of money.  Given that less than 3% of U.S. households earn above $250,000 a year and the median price of a home in the U.S. today is roughly $150,000, I am not sure how this is going to raise much money at all.  It will affect a relatively small number of people on an even smaller number of transactions.

But that does bring up another point – and this is a close as I will come to a political discussion.

It’s Only A Little Tax – You Can Afford It!
At the event, my point to the lady asking the question and to the audience had nothing to do with the size of the tax or if it even existed.  She was there to learn how to be a better real estate investor.  She had an opportunity to network and learn from 450 other investors from all over the country.  Too often, we focus on the negative and not the positive and the negatives tend to get us a lot more fired up!  When they do, our focus is all over the boards and not on the basics, which will ultimately cost each of us a lot more than a tax.

When I came off the stage a man was waiting for me and I guess he surmised from my answer that I was all for the healthcare plan and all for redistributing wealth.  He mentioned how “all them conservatives make such a big deal when asked to give a little”.  I asked him what he meant by his comment and he said that 3.8% was a small tax and if you are making money in real estate, who cares about giving a little.  I told him that I thought he was missing the point of all those that were tired of giving a little.  He had this perplexed look on his face and I said that I thought if he added one word to his statement he might understand where they were coming from.

It wasn’t that people don’t want to give a little.  It is that each time they are being taxed to give a little “MORE”.

Ultimately, this new tax is now the law of the land and we’ll see if the legislature removes it.  I think that is a highly doubtful proposition.  In the end, none of us is going to stop making money simply because there is a new tax attached to it.  Just know that it will affect a very small number of people on a very small number of transactions and as real estate investors we have much bigger issues to focus on!

UPDATE:  Here are the sources I used  – all found by entering the question into Google:

Photo: LaDawna Howard

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About Author

In 2005, Chris Clothier (G+) began working with other investors and has since helped hundreds of investors purchase over 2,300 properties in Memphis, Dallas and Houston through the Memphis Invest family of companies.

51 Comments

  1. Chris,

    This may be the best article (in layman’s terms) I have read on this subject. We discussed this “tax” at one of our sales meetings almost a year ago and I am sure most of our sales force still do not comprehend it. I will share this with my team and peers as I believe those that take the time to read it will find it as insightful as I did. Thank you.

    • Chris Clothier

      Jim –

      Thanks for reading the article – not sure if this one should be considered as anything definitive though! NAR has some very good information including a PDF with scenarios outlining the effects of the legislation and multiple scenarios. They also have an FAQ on their site.

      Thanks for leaving a comment – Chris

  2. Chris Weiler on

    Chris C., from what I have found the $500,000/$250,000 home sale exclusion only applies to a primary residence. It seems those of us who flip houses for a living and make over 200K/250K may be stuck with an additional 3.8% tax. Considering the reduced margins of many transactions these days, an additional 3.8% could kill a deal. We will all have to come up with some creative solutions to avoid this tax.

    • Chris Clothier

      Hey Chris –

      You are correct on your point. The scenario I laid out for exclusion is on a primary residence. However, as a real estate investor, you will have a ton of options to help avoid this tax depending on the nature of your investing. Many of these will be left to you and your CPA and exactly how you operate, but if you earn $750,000 next year as a real estate investor and incur expenses of $530,000 and are a couple – then your AGI or adjusted gross income is under the $250,000 threshold and you are not subject to the tax. If you are a full time investor and earn $300,000 and have no expenses, then your tax will amount to 3.8% of $50,000 which is the amount above your exclusion.

      I hate taxes and I think this one is B.S. and I don’t think there is a way in hell it will raise $21 billion a year for a bankrupt medicare program. Mostly because full-time real estate investors incur a lot of expenses and most will expense their way below the $250,000 threshold.

      But you were correct – the $500,000 exclusion for couples is on primary residences.

    • Chris W., from my reading of the existing law, the 3.8% applies only to ‘net investment income.’ If you flip houses for a living your profits, in my opinion, are ‘earned’ income. Unless you have other investments generating income the 3.8% tax would not apply :)

  3. Jeff Brown

    Guys, the cap gains tax, at least what I’ve seen so far, rises from 15% to over 23% in the health care bill. Happy days.

    And Chris — Am I to believe you were in my town, talking to investors, and I don’t even get a courtesy call tellin’ me to go to hell? :)

    • Chris Clothier

      Jeff –

      I should have done my research to know which town you are in first!! But, I am in your neck of the woods every few weeks and will for sure meet up next time.

      My article was short and broad – BUT – your point is a major part of my argument to new investors (and seasoned investors alike) that we have major issues to be aware of. A 3.8% tax that will effect relatively few of us is small when compared to a major tax increase that will effect us all! We need to keep our heads down and pay attention to all of the details in our everyday business because what may have been small mistakes before become amplified now.

      I look forward to seeing you soon – I’ll be back in SD at the end of July.

      Chris

  4. The 15% long term capital gains tax expires next year, rising back to 20%. There some obscure 1.2% tax increase only for high income people, and the 3.8% capital gains surtax for high income real estate investors. The one thing not mentioned in any of the articles is whether or not carry forward depreciation can shield any of this?

    • Chris Clothier

      Greg –

      Great points you brought up. I inserted one sentence at the end of my article about he legislature and it helps to point out that none of the rules for implementation on some of this have been written yet. We do not know how tax shelters such as 1031 exchanges are going to be affected or how depreciation carry forward on sales or loss carry forward on rental income is going to work.
      I will point out since you use some of the same language that I use, that this is a tax on high-income earners. When others ask why high income earners object to relatively small taxes – it is because they are all relatively small taxes. Each one of them! That get constantly added to a small group of people that are always told to give —More.

      • Amen. I always like to ask a foundational question: how much is enough? If you constantly work from the “more” category, then what is small today will be big tomorrow. I have heard stories of how decades ago, government officials would predict the cost of some public school system to be twice what they were currently receiving. Now, they are way past receiving twice, but yet, they still want “more.” It’s a never ending story!

    • Greg, according to the law as it now exists ‘net investment income’ includes ‘net rental income.’ This, in effect, is the income that you report on your Schedule E. Carry forward depreciation will shield your income from the 3.8% tax to the extent that it reduces your Schedule E income. Hope this helps :)

      • Chris Clothier

        Bill –

        In determining the rules for application of each of the new pieces of this law, have they already decided how depreciation will shield investors from this tax? I understand the Schedule E income reporting, but is there any chance they write the rules to ignore the depreciation carry forward and look at income before this calculation? They are calculating this new law to raise an awful lot of money.

        • Interesting point Chris. At THIS point, there is no requirement to ignore depreciation when computing net investment income from rental property. The amount to include in net investment income is the amount from the taxpayers’ Schedule E. You raise an interesting point when you say “[t]hey are calculating this new law to raise an awful lot of money.” Most legal/political pundits that I follow are saying the 3.8% will not make a dent in the funding required for the Affordable Care Act.

  5. Brian Levredge on

    It should also be noted, that like other taxes, the surcharge is not indexed for inflation either. Remember that the AMT when passed was only supposed to affect the top 1-3% of income earners as well.

    • Chris Clothier

      Thanks for reading and taking the time to respond Brian. As usual, we are dealing with Washington. No one really knows the future of this and according to NAR, it was only added after the original bills passed during reconciliation and at the last minute. It is intended to cover the gap in medicare funding as the program runs out in the next couple of years and they intend for this new tax to raise $210 Billion over 10 years. We all know just how “accurate” these forecasts can be.

      Chris

  6. Hey Chris! Excellent analysis. Being the political junkie and tax geek that I am, I did a pretty thorough reading of HR 4872 Health Care and Education Reconciliation Act of 2010 when it was signed into law. I’d like to offer the following comments for consideration.

    : Effective January 1, 2013 there is a new 3.8% tax
    : It is NOT a tax on all real estate transactions.
    : It IS a Medicare tax on “NET INVESTMENT INCOME” over a certain threshold.
    : Many people will not have to pay this tax.

    Who does this affect? The best answer, I think, comes from the law itself. The Act says:

    “(a) IN GENERAL.—Except as provided in subsection (e)—
    (1) APPLICATION TO INDIVIDUALS.—In the case of an individual,
    there is hereby imposed (in addition to any other tax
    imposed by this subtitle) for each taxable year a tax equal
    to 3.8 percent of the lesser of—
    (A) net investment income for such taxable year, or
    (B) the excess (if any) of—
    (i) the modified adjusted gross income for such
    taxable year, over
    (ii) the threshold amount.
    (b) THRESHOLD AMOUNT.—For purposes of this chapter, the
    term ‘threshold amount’ means—
    1) in the case of a taxpayer making a joint return under
    section 6013 or a surviving spouse (as defined in section 2(a)),
    $250,000,
    (2) in the case of a married taxpayer (as defined in section
    7703) filing a separate return, 1⁄2 of the dollar amount determined
    under paragraph (1), and
    (3) in any other case, $200,000.

    What this seems to mean:

    : The tax would not be imposed until the threshold of $200K for singles or $250K for married filing jointly is exceeded.

    : The 3.8% would be imposed on the LESSER of the net investment income OR the modified AGI in excess of the threshold.

    : If you have NO ‘net investment income’ you will not pay the surtax even if your income exceeds the threshold.

    Net investment income, as far as I can determine, includes capital gains, rents, dividends and interest income. It also comes from some investments in active businesses IF the investor is not an active participant in the business. The portion of investment income that is subject both to income tax and the new Medicare tax is the amount of income derived from these sources, reduced by any expenses associated with earning that income. (Hence the term “net” investment income.)

    Wholesalers rejoice. Income from “flipping” is generally considered EARNED income, NOT investment income, and wouldn’t be subject to the surtax :)

    This is definitely a convoluted piece of legislation, and you should certainly run this stuff by your own tax pro. Only he or she can definitively advise you about your individual tax situation.

    Just my .02…

  7. Thanks for takin the time to do the research. I really don’t have a problem with paying, if they were not so free with spending the money they get. All I want from the government is keep our boarders safe and give me somewhat nice roads to drive on. Other than that, I don’t want it!

    • Chris Clothier

      Rob –

      Thanks for taking the time to read and comment on the article. You share a sentiment that many of us have. If only Congress played by the same rules that we have to run our own households…we might not be in this mess.

  8. Chris,

    Thank you for spelling it out for the laymen. This does go back to the need to have an Real Estate Investors group that can lobby for us. We hire experts in many areas; CPA’s, brokers, lawyers, electricians, flooring specialist etc etc. Yet we fail to band together and get someone working for us locally and nationally in the influence of future laws rules and regulations. Makes no sense to me.

    Jason

  9. One thing I want to point out. You are talking about the exclusion on real estate. Very important point being that is only on your principle residence. Assuming you are flipping residences, this applies, but most investment on real estate does not qualify for the exclusion. Otherwise you seem to have it right.

    • Actually, Timothy, the 3.8% tax will NOT apply to “flipping residences.” Flipping (either wholesaling or rehabbing) in most cases is considered earned income. The 3.8% tax isn’t assessed on earned income, but on “net investment” income.

    • Chris Clothier

      Timothy –

      Thanks for the reply. You are correct, the $500,000 exclusion was for a personal residence sale. As Bill correctly points out, the law only applies to passive income, so actively ‘flipping’ homes will shield you from this law provided that your income eclipsed the $250,000 to begin with.

  10. I don’t believe this tax is applied to rental income for real estate professionals. If you meet the real estate professional status and your investing is a trade or business, the 3.8% tax will not be charged on your rental income.

    • Right Kyle. As long as the income is classified as EARNED income and not INVESTMENT income it’s not subject to the 3.8% tax . . .at least for now :)

    • Chris Clothier

      Kyle –

      I had pointed out in an earlier comment that there are some thresholds you have to meet first in order for this tax to take effect. Of course, if your income is all earned income – as a real estate professional – you might as well prepare for the .9% tax increase for Medicare on earned income.

      The really unfortunate tax payer will be the one who earns an income above the threshold and gets the .9% tax increase AND invests wisely enough to get the 3.8% tax as well. That investor is looking at a 4.7% increase in his effective tax rate and that’s only on the Medicare tax portion of this law. There are possibly many more tax increases depending on the situation.

      Regardless, the point still remains that a relatively small number of Americans will be effected and real estate investors do not need to scream that the sky is falling and start dumping their portfolios. The time is now to begin tax preparation – especially if you are one of the “lucky” investors doing very well.

      Thanks for posting – Chris

      • Good points Chris. An additional point to remember is that the .9% is actually a “payroll tax” increase. In other words, it’s assessed against wages or income subject to self-employment tax in excess of the threshold. This is a good reason for real estate investors who wholesale or rehab to consider using an S-Corporation or, better yet, an LLC electing to be taxed as an S-Corporation as their entity of choice :)

        • Bill, I had a tax law class last semester and it was actually my favorite class of the semester. While I don’t enjoy paying taxes and think a lot of the laws are written poorly, I like understanding the laws and their implications on my investing.

          I think we may have been talking about two different things. Dealer status would make you subject to self employment tax, but if you are not a dealer, but an active real estate investor and a real estate professional under the IRS guidelines and your investing in rental property is classified as a business or trade; then you would not be subject to self employment tax and would still file Schedule E for your rental income. However, because it is an active investment, doesn’t that exempt it from the 3.8% tax?

          That is the impression I had from a previous forum discussion on the topic and the information in this article: http://www.aicpa.org/Publications/TaxAdviser/2011/July/Pages/fava_jul2011.aspx#fnref_16.

      • If your real estate investing qualifies as a trade or business (confirmed by meeting the IRS real estate professional guidelines), your rental income is active and not included in the 3.8% tax and also is not subject to self employment taxes and the increased medicare payroll tax rate or any social security taxes.

        • Kyle I agree with your first assessment, but disagree with your second. When you are classified as real estate dealer your activity is, in fact, treated as a “trade or business.” Accordingly, the income would not be included in the “net investment income” calculation for the 3.8% tax. It does, however, become subject to self-employment tax which will make any amount in excess of the threshold subject to the .9% increase. Don’t ya just love tax law?

  11. In all honesty, I think the questioner wanted a rant session against the Affordable Health Care Act, rather than to really discuss learning the finer points of the real estate business…

    Or, she simply didnt google the answer herself and read this information. Or asked a CPA, which she should have if she takes all the advice thrown at us from these forums. All in all, good answer to keep focused on our business!

    • Chris Clothier

      Hey Lisa –

      Thanks for taking time to read and respond to the article and you may be right. A lot of people do want to rant and rave. I had spoken to this particular woman several times at many events and she is an active investor and does have properties that she holds for long-term rental gain as well as flip homes in California. In terms of actually getting off the couch and making something happen – I would say she is very successful.

      She could have easily asked in private so I think she really wanted to ask in front of other investors either to help them get informed or to look like someone who is in the know and wants to draw a crowd. Who knows?

      I think you are correct with your last statement and I will say it again. This is something that you should be aware of and for some, they should be talking to their CPA now to prepare. For a vast majority of investors, focusing on buying the right house, hiring out the right teams, watching details that actually make us money should be priority #1.

  12. But Lisa, she asked that question of Chris BEFORE he wrote this article, so she didn’t have the benefit of the superb analysis which has been presented here. And if she hadn’t asked the question Chris may not have written this article which led to such great interaction among us BP’ers… ;)

    • Good question Paul. It depends on the type of earnings of the LLC and how the LLC has elected to be taxed. If the LLC holds your rental property and the income is passed through to your personal tax return, the net rental income would be part of the “net investment earnings” and subject to the tax. Earned income, such as income from wholesaling and rehabbing which passes to your personal return would not be subject to the tax. If the LLC is being taxed as a C-Corporation the earnings are not subject to the 3.8% tax as this applies only to individuals. Again, this is both a convoluted and complicated piece of legislation. If your income will exceed the threshold you should be doing some planning with your tax pro. Hope this helps :)

      • Chris Clothier

        Bill –

        Thanks for breaking that down. I’m sure both of us will be watching as the rules are written for the application of this new law. I’ll probably come back and lean on you for updates to get your understanding of the rules as they get published. Thanks again for taking so much time to answer all of the detail questions on here.

        All the best –

        Chris

  13. Laurice McCoy on

    Thank you, thank you, thank you. All the hype about it being a tax that will affect every day people with average income got out of hand. But you won’t hear the truth in coperate media.

    • Chris Clothier

      Hey Laurice –

      Thanks for the reply and the input. I’m not sure about corporate media and I don;t know in the end how much coverage or sympathy investors will get on this. I do appreciate you taking the time to respond though –

      Chris

  14. I don’t care if this tax just effected .0001% of Americans. Its 1) a tax 2) penalizing an individual who is succeeding in business (The American Dream). Just another reason to get out and vote in November…

    • Chris Clothier

      Watson –

      Thanks for your comment on the article. I appreciate you taking the time to read and leave your input. You are correct about who the tax effects – it is those who are succeeding at investing. And do not forget that they are investing after tax dollars. So as citizens we have paid taxes once, decided to take a chance on an investment, made additional money and being taxed on those gains. It seems rather comical for anyone to think that is a “fair” system, but it is how it has been set up. It is a good idea that we all know what the rules are as we approach the end of the year.

      On the other comment – if anyone needs another reason to vote their priorities may be a little off. I mean, after all, the fact that we are free to vote how we choose should be reason enough to exercise it…just saying.

      Thanks for commenting –

      Chris

  15. So I found your article while trying to learn more about this tax and am trying to make sense of it all. In reading comments and many many articles yours seems the most helpful. Was wondering if you have any idea about our situation to help shed some light on it for us. My husband has a company where they fip houses, will the tax apply to the houses since it is an investment property or is the income come into play there on when the tax would apply to them? If anyone has any idea or knows how it will affect them I’d love some insight on this.

    • Hi Nicole –

      Income from ‘flips,’ in general, is considered EARNED income, NOT investment income. The houses are considered inventory, not investment property. So, the income will not be subject to the 3.8% surtax. That being said, flips CAN sometimes be considered investment income so you need to consult your tax pro on your specific situation.

      Hope this helps.

      Bill

    • Chris Clothier

      Nicole –

      Bill just gave you some of the best advice you could ever get and that is to take what you learn here and consult your CPA. IN fact, I would not just consult any CPA, but consult one with experience both as a real estate investor and with preparing years worth of returns for real estate investors. This is the type of person who will be able to help answer your questions and point you in the right direction. If you need a referral, I would be happy to give you one of those as well!

      Thanks for taking time to read and comment on the article.

      All the best – Chris

  16. The great thing about these tax changes being so controversial is that taxpayers are actually paying attention!

    The first important step as a real estate investor is to be structured properly, and the way to learn how to structure is through your CPA and/or tax advisor (who, hopefully, specialize in real estate!). I know investors who pay too much tax, Obamacare or not, because they don’t take the time or spend the money to set up their investing business as a business, including Articles of Incorporation, so that they can take advantage of all the tax breaks owning real estate affords.

    Thanks, Chris, for your article and for encouraging the dialog.

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