How New Medicare Tax Could Impact Real Estate Investors

Beginning January 1, 2013 a new Medicare tax will take effect on some investment income. Real estate investors who have passive income from their real estate properties could be impacted by a new 3.8% Medicare tax if they pass certain thresholds. Medicare is a federal health insurance , so Medicare Eligibility is unquestionable. Let’s first take a look at the difference between a passive real estate investor and an active real estate investor.

If you own part or all of an income generating property, but do not actively participate in the management of the property, you’re considered a passive investor. On the other hand, if you’re actively engaged in managing the property and/or live on the premises you might be considered an active investor. To qualify under the residency guidelines you must live at the property for at least 10% of the time you’re receiving income from it. You can also qualify as an active manager of the property if you’re a real estate professional who spends at least 750 hours per year engaged in the real estate trade.

Passive real estate investors, or investors who hold some passive income properties will be subject to the 3.8% Medicare tax if they have an adjusted gross income of more than $200,000/year as an individual or $250,000/year if they file a joint tax return. This tax will apply to interest, dividends, rents (less expenses) and capital gains (less losses). This means that investors and casual sellers could be impacted by the new tax. For example, if you sold your principal residence and earned more than the adjusted gross income threshold, any capital gains from the sale could be subject to the 3.8% Medicare tax. The National Association of Realtors (NAR) has created a very informative brochure that highlights all of the various scenarios where a real estate investor or casual seller could be hit with this tax.  And since the tax is new, effective strategies for minimizing the tax have not yet been tested. However it seems that there are a few options being considered:

  1. Immediately assess your vulnerability to the new Medicare tax by speaking with your accountant about your real estate holdings.
  2. Work with your accountant to implement strategies to minimize your vulnerability to the new tax. For example, you might consider unloading investment properties before the new tax law goes into effect.
  3. Increase allowable expenses on your properties. You might consider spending money for property improvements or maintenance so that your net capital gains are reduced.
  4. Increase your activity level in managing your real estate holdings so that you qualify as an active investor.

To learn more about how to qualify as an active real estate investor visit the IRS. You can also learn more about the new Medicare tax by reading a brochure created by NAR.

 

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