Rumors about the 3.8% Medicare tax continue to circulate. Here's the definitive word on what's true and what's not on how the tax impacts real estate.

Ever since health care reform was enacted into law more than two years ago, rumors have been circulating on the Internet and in e-mails that the law contains a 3.8 percent tax on real estate. NAR quickly released material to show that the tax doesn’t target real estate and will in fact affect very few home sales, because it’s a tax that will only affect high-income households that realize a substantial gain on an asset sale, including on a home sale, once other factors are taken into account. Maybe 2-3 percent of home sellers will be affected.

Nevertheless, the rumors persist and the latest version that’s circulating falsely say NAR is advocating for the tax’s repeal. But while NAR doesn’t support the tax (it was added into the health care law at the last minute and never considered in hearings), it’s not advocating for its repeal at this time.

The characterization of the 3.8 percent tax as a tax on real estate is an example of an Internet rumor, says Heather Elias, NAR’s director of social business media. Elias and Linda Goold, NAR’s director of tax policy, sat down for a discussion of how the tax works and how Internet rumors work and you can find their remarks in the 6-minute video below.

Goold says the tax will affect few home sellers because so many different pieces must fall into place a certain way for the tax to apply. First, any home sale gain must be more than the $250,000-$500,000 capital gains exclusion that’s in effect today. That’s gain, not sales amount, so you really have to reap a substantial amount for the tax to even come into play. Very few people are walking away with a gain of more than half a million dollars today, even in the high-end home market, so right off the bat only a few home sellers would be a candidate for the tax.

For the few households that do see a gain of more than the $250,000-$500,000 exclusion (that’s $250,000 for single filers and $500,000 for joint filers), only the amount above the exclusion would be factored into the tax calculation, and that would still only apply to high-income households, which the law defines as single people earning $200,000 a year and joint filers earning $250,000 a year.

So, if you are a households with annual income of $250,000 or more and you earn a gain of more than $500,000 on your house (again, that’s after the $500,000 exclusion), any amount of gain above the exclusion would be plugged into a formula to see if it’s taxable. If it turns out that it’s taxable, then the amount could be subject to the 3.8 percent tax. If the household had a gain of more than $500,000 but only earned $249,000 a year in income, the tax wouldn’t apply.

(Note that these are just hypothetical examples. To know if a case would really be subject to the tax, a professional tax preparer or tax attorney has to look at all the particulars of the tax filer’s case. Only a tax professional is in a position to say the tax is applicable, but the examples cited here could help you get a sense of how the tax works.)

The other thing about the tax worth noting is that, although it takes effect in 2013, any impact on taxes wouldn’t happen until 2014. That’s because the tax filer would do the calculation in 2014 for the 2013 tax year. Because it’s not a tax on a real estate sale but rather on a capital gain, it’s not calculated at the time of an asset sale, whether that asset is a house or something else. It’s calculated at the time the filer figures his or her tax.

This is all explained clearly in the video, so if you have questions about how the tax works, or if you’re still hearing rumors about the tax and you’re not certain of the accuracy of what you’re hearing, the video should prove helpful.

Source: http://realtormag.realtor.org/news-and-commentary/feature/article/2012/10/38-tax-whats-true-whats-not

Keeping track of the cost of capital improvements to your home can really pay off on your tax return when it comes time to sell.

It’s no secret that finishing your basement will increase your home’s value. What you may not know is the money you spend on this type of so-called capital improvement could also help lower your tax bill when you sell your house.

Tax rules let you add capital improvement expenses to the cost basis of your home. Why is that a big deal? Because a higher cost basis lowers the total profit—capital gain, in IRS-speak—you’re required to pay taxes on.

The tax break doesn’t come into play for everyone. Most homeowners are exempted from paying taxes on the first $250,000 of profit for single filers ($500,000 for joint filers). If you move frequently, maybe it’s not worth the effort to track capital improvement expenses. But if you plan to live in your house a long time or make lots of upgrades, saving receipts is a smart move.

What counts as a capital improvement?

While you may consider all the work you do to your home an improvement, the IRS looks at things differently. A rule of thumb: A capital improvement increases your home’s value, while a non-eligible repair just returns something to its original condition. According to the IRS, capital improvements have to last for more than one year and add value to your home, prolong its life, or adapt it to new uses.

Capital improvements can include everything from a new bathroom or deck to a new water heater or furnace. Page 9 of IRS Publication 523 has a list of eligible improvements. There are limitations. The improvements must still be evident when you sell. So if you put in wall-to-wall carpeting 10 years ago and then replaced it with hardwood floors five years ago, you can’t count the carpeting as a capital improvement. Repairs, like painting your house or fixing sagging gutters, don’t count. The IRS describes repairs as things that are done to maintain a home’s good condition without adding value or prolonging its life.

There can be a fine line between a capital improvement and a repair, says Erik Lammert, tax research specialist at the National Association of Tax Professionals. For instance, if you replace a few shingles on your roof, it’s a repair. If you replace the entire roof, it’s a capital improvement. Same goes for windows. If you replace a broken window pane, repair. Put in a new window, capital improvement. One exception: If your home is damaged in a fire or natural disaster, everything you do to restore your home to its pre-loss condition counts as a capital improvement.

How capital improvements affect your gain

To figure out how improvements affect your tax bill, you first have to know your cost basis. The cost basis is the amount of money you spent to buy or build your home including all the costs you paid at the closing: fees to lawyers, survey charges, transfer taxes, and home inspection, to name a few. You should be able to find all those costs on the settlement statement you received at your closing.

Next, you’ll need to account for any subsequent capital improvements you made to your home. Let’s say you bought your home for $200,000 including all closing costs. That’s the initial cost basis. You then spent $25,000 to remodel your kitchen. Add those together and you get an adjusted cost basis of $225,000.

Now, suppose you’ve lived in your home as your main residence for at least two out of the last five years. Any profit you make on the sale will be taxed as a long-term capital gain. You sell your home for $475,000. That means you have a capital gain of $250,000 (the $475,000 sale price minus the $225,000 cost basis). You’re single, so you get an automatic exemption for the $250,000 profit. End of story.

Here’s where it gets interesting. Had you not factored in the money you spent on the kitchen remodel, you’d be facing a tax bill for that $25,000 gain that exceeded the automatic exemption. By keeping receipts and adjusting your basis, you’ve saved about $3,750 in taxes (based on the current 15% tax rate on capital gains). Well worth taking an hour a month to organize your home-improvement receipts, don’t you think?

Watch out for these basis-busters

Some situations can lower your basis, thus increasing your risk of facing a tax bill when you sell. Consult a tax advisor. One common one: If you take depreciation on a home office, you have to subtract those deductions from your basis. Any depreciation taken if you rented your house works the same way. You also have to subtract subsidies from utility companies for making energy-related home improvements or energy-efficiency tax credits you’ve received. If you bought your home using the federal tax credit for first-time homebuyers, you’ll have to deduct that from your basis too, says Mark Steber, chief tax officer at Jackson Hewitt Tax Services.

This article provides general information about tax laws and consequences, but is not intended to be relied upon by readers as tax or legal advice applicable to particular transactions or circumstances. Readers should consult a tax professional for such advice, and are reminded that tax laws may vary by jurisdiction.

Donna Fuscaldo has written about personal finance for more than 10 years at the Wall Street Journal, Dow Jones Newswires, and Fox Business. She’s currently remodeling her home—and aiming to make a profit on it one day.

Source: http://www.houselogic.com/articles/tax-breaks-capital-improvements-your-home/