Long-term homeowners with significantly appreciated properties are in for an unpleasant surprise when they sell their home. Uncle Sam may take a big chunk of their retirement savings from the sale of their house in many high value communities, such as Greenwich, New York City, San Francisco, Los Angeles and Honolulu. This may happen even if the house is relatively modest. If the homeowners refinanced their house they may find they have no retirement savings at all and could even have to come out of pocket to sell their house with these new taxes.
The first graph shows the date of acquisition of residential property with more than $500,000 in gain based on information from the Greenwich Tax Assessor's office. As you can see the largest numbers are the houses bought from 1991 to 2001. A third to a half of the houses in Greenwich could be subject to the new fiscal cliff and Medicare investment tax increases. Unlike the much publicized $450,000 threshold for higher capital gains taxes in the fiscal cliff bill, the new 3.8% Medicare investment tax kicks in at $250,000 AGI for a couple. This is on top of the prior years’ 15% capital gains tax, so couples are looking at an 18.8% tax and if their gain exceeds $450,000 their tax rate will be 23.8%.
The second graph shows the acquisition date of all Greenwich residential properties (red line) and those with more than $500,000. For nearly everyone who bought their house before 1982 and held on, they have more than $500,000 in gain. As a result, all of these long term residents may be subject to the new 3.8% Medicare investment tax on top of a 15% capital gains tax. A lot of people decided not to take the chance on the new taxes and December 2012 was a record for that month with 68 sales reported so far by the GMLS. This is nearly double the 36 homes sold in December 2011.
For people who refinanced they may find that after they pay the mortgage, the capital gains tax, the Medicare investment tax, the Connecticut conveyance tax, real estate commissions and legal fees, the funds that they were depending on for retirement are substantially smaller than they expected and could even be a loss. For people who have retirement bonuses and sell their property in the same year, the problem is particularly acute as these one-time income events combine to kick them into much higher tax bracket for that year.
The law does provide a $500,000 capital gains exemption for married couples selling their primary residence, but for single people, including widows who stay in their home, the exemption is only $250,000 and the taxes kick in at lower income limits. If the property is not their primary residence then there is no exemption and the full 23.8% rate may apply.
The sale of highly appreciated real estate has become hugely complex with the addition this year of the new fiscal cliff tax and the Medicare investment tax. To further complicate matters, none of the new regulations have been written for the Medicare tax. Without talking to an accountant or tax lawyer and considering all acquisition and selling costs you can't know whether the new taxes will apply to your situation.