Tax Law

The Truth About Federal Income Tax Laws and Selling Your Home

Some angry e-mails have been circulating about real estate tax stating that all sales of real estate are subject to a 3.8 percent sales tax. The e-mails cite specific examples, saying that if you sell your home for $400,000, you will be subject to a $15,200 tax. Before you get mad, get the truth about federal income tax laws on capital gains relating to the sale of your house.

The e-mail is referring to a Medicare tax of 3.8% on investment or unearned income for high income taxpayers, or those individual taxpayers who report income over $200,000 and married taxpayers filing jointly who report income over $250,000. Keep in mind that in 2008, only three percent of individual taxpayers made over $200,000. Investment income is money made from investments, not including distributions from qualified retirement plans like pensions and IRAs.

Regarding selling your home, qualifying individual taxpayers can exclude up to $250,000 worth of the gain from the sale of a primary home, while qualifying married taxpayers can exclude $500,000. The e-mail is also incorrect in that this exclusion is not on the net proceeds (or how much you sell your house for), but on the gain from the sale. The taxable amount before figuring in the exclusion is calculated subtracting the basis from the sale price. The basis usually equals the original cost of your home plus capital improvements and adjustments. This gain amount is also excluded from the Medicare tax to which the e-mail refers, regardless of your income total. Consider here that the median sales price, not even the median capital gain amount, for homes in 2008 was $181,300. Taxes do apply, however, to vacation homes regardless of how much you make on the sale.

So, for the Medicare tax to actually apply to you, your income must be above the threshold amounts and your gain from the sale of your home must be above the exclusion amounts. To break this down, let’s say you are single and your income is $210,000. Let’s say you then sell your home which you initially bought for $400,000 for $750,000. This means that your gain from the home sale is $350,000. Since your income is over $200,000 and since your net gain is over $250,000, you will be taxed on the remaining $100,000 you gained from selling your home, but not the first $250,000. If you do not meet all of those qualifications, you do not have to worry about the tax.

The rationale behind this is that for Medicare taxes, there is no cap on the wage amount from which the tax is taken, meaning that everyone has Medicare taxes taken out. However, without this tax, people whose incomes come mostly from passive sources, like investments, and not their wages would otherwise not be fairly taxed for Medicare.