Q: I have received emails saying that if you sell your home in 2013, you must pay a 3.8% Medicare tax on the sale. This greatly concerns me because I will be putting my home on the market next year. Do you know anything about this? Is it true or just another urban legend? Thank you for your help.
A. There is a great deal of misunderstanding regarding the new Medicare tax on unearned income with respect to the sale of a principal residence.
Here's how it works: The new 3.8% Medicare tax becomes effective for 2013. It applies to the lesser of "net investment income" or the excess of your "modified adjusted gross income" over certain threshold amounts. The threshold amounts are $250,000 for married taxpayers filing a joint return, $200,000 for single and heads of household, and $125,000 for married taxpayers filing separate returns.
Capital gain income is included in "net investment income." Gain from the sale of your principal residence may create capital gain income, but only to the extent that it exceeds the "section 121" exclusion. If you used the property that you sell in 2013 as your principal residence for at least 3 of the last 5 years, and you haven't claimed the exclusion on the sale of any other residence in the last two years, you may be able to claim the exclusion. The exclusion is the lesser of the gain from the sale of the residence or $500,000 if you are filing a joint return, $250,000 if you are filing single or head of household.
In order for the gain from the sale of your principal residence to be subject to the new 3.8% Medicare tax it will have to exceed the $500,000/$250,000 section 121 exclusion, and your modified adjusted gross income, including the taxable portion of the gain, will have to exceed the applicable threshold amount mentioned above.
Unless the gain from the sale of your principal residence is very large, or you don't qualify for the section 121 exclusion, and your modified adjusted gross income is over the applicable threshold amount, the gain from the sale of your principal residence probably won't be subject to the 3.8% medicare tax.