Easy Strategy to Avoid New Surtax for Real Estate Investors


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There is a brand new Medicare surtax hitting passive investors this year. It’s 3.8% and hits anyone who makes over $200,000 (single) or $250,000 (married filing jointly).

Your first thought might be that you don’t currently hit that minimum income amount and so it doesn’t apply to you. But you may want to look at that again, especially if you have real estate. You may be only a couple of quick real estate sales away from the limit.

Even if your income qualifies you, you may still be able to escape the surtax. Let’s look further at the definition. This tax only hits what is called “net investment income.”

And this is where it may get a little complicated. The IRS has definitions for real estate investors, some of which you may have never heard. You could be a real estate dealer, real estate professional, real estate developer or real estate investor or you could be a combination of two or more.

In this case, the real estate dealer definition can save you on taxes. If you’re a real estate dealer it means that you buy and sell properties. You don’t buy them to hold on to them for long period of times. You may wholesale them. You may do a fix ‘n flip. Whichever specific strategy you’re using, you are a real estate dealer if you’re in it for the sale that happens after a short period of time.

A real estate investor, on the other hand, buys property to hold on to them. If he sells, it’s after a period of time.

In the case of a real estate dealer, the sale of the property is the same as the sale of any other product a business could have. In other words, a real estate dealer has a business.

In the case of a real estate investor, he has property that is an investment. When he sells, he gets capital gains treatment. It’s short-term capital gains if he’s held it for less than a year. Over that amount, and it’s long term, and a lower tax rate than you’d get with a short-term capital gains.

As a real estate dealer, you are not subject to the Medicare surtax. As a real estate investor, you are.

You may be a real estate dealer and also be a real estate investor. It is a property-by-property determination.

This is where a good tax strategy comes into play. You need to know what you want, and then, as much as you can within the legal parameters you make your case fit the requirements.

For example, if you’ve held a property for a few years and you’re normally considered a dealer, what will it take for that to be considered an investment and not a business? Make that decision and you’ll get long-term capital gains treatment instead of ordinary income tax. You will likely have to pay the Obamacare Medicare tax.

On the other hand, let’s say you are flipping a lot of property. Your biggest concern is the Medicare tax. You can’t get capital gains treatment because you haven’t held the properties for a year, so there is no upside to being called an investor. You want to be a dealer. How do you set up to make sure you’re a dealer?

The new surtax is just one more component to figuring out the best strategy. If you’re a dealer, you won’t pay it. If you’re an investor, and you sell, you probably will. A good strategy with advance planning will get you what you need.

Tax law is changing! Get up to speed quick for FREE! on our next webinar “Real Estate Tax Strategies: Updates for 2013 and Beyond” . Sign up at http://www.DianesSeminars.com.



One Comment

  1. Ed Horan says:

    Ed Horan
    As so many have pointed out, including yourself, while a taxpayer would normally not have income over the 3.8% Medicare tax thresholds of $200,000 for individuals, and $250,000 for couples filing jointly, the gain from the sale of an investment property will most likely make them liable for the tax. Most strategies promoted to avoid the 3.8% tax fail to mention the use of the 1031 exchange of the sold/relinquished property.
    While a close look at tax rules will show you a 1031 exchange tax deferral will escape the tax, in the summary to the draft regulations implementing IRC section 1411 it is clear that deferred gain from a 1031 exchange will not be counted as part of your net investment gain. It states ‘for example, to the extent gain from a like-kind exchange is not recognized for income tax purposes under section 1031, it is not recognized for purposes of determining net investment income under section 1411”.
    When advisors talk of strategies to lessen the impact of the 3.8% Medicare tax, they should be sure to include the use of the 1031 exchange.
    For more information on a 1031 exchange contact Bill Horan, CES® of Realty Exchange Corporation, at toll free 1-800-795-0769, cell 703-606-2761, or bill@1031.us.

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