The Capital Gain Tax Rate will increase in 2011 from 15% to 20% per the sunset provisions in the current law. On top of the 5% increase, starting in 2013 a new Medicare Contribution Tax, IRC § 1411, will subject the “net investment income” of individuals, estates and trusts to an additional 3.8% tax to the extent the taxpayer’s “modified adjusted gross income” (MAGI) exceeds threshold amounts. “Net investment income” includes capital gains from sales on investment properties and rentals (property held in a passive activity). Thus, it will apply to most 1031 properties held by individuals, or by partnerships and S corporation. It will not apply to properties used in an active trade or business or by a C corporation. The income thresholds are $250,000 for married couples and $200,000 for other taxpayers.
The definition of net investment income applies the tax to MAGI above the threshold levels “to the extent taken into account in computing taxable income.” Thus, gain deferred under Section 1031 should not be subject to the tax, although regulations have yet to be issued.
Example A:
A single taxpayer has MAJI of $150,000, including $100,000 of gain from a rental home. The tax does not apply because the MAJI is less than $200K.
Example B:
A single taxpayer has MAJI of $250,000, including $100,000 of gain from a rental home. The tax applies to $50,000 of the gain (the net investment income in excess of MAJI).
Example C:
A single taxpayer has MAJI of $300,000, including $100,000 of gain from a rental home. The tax applies to the full $100,000 of gain.
