Can a 1031 defer the new Medicare Contribution of 3.8% passed under health care reform?
Q: I have heard that there is something in the new health care act that will increase the taxes due on the sale of an investment property. It’s related to Medicare. What is it and can a 1031 exchange defer this tax too?
A: Yes it can. When The Health Care and Education Reconciliation Act of 2010 became law in 2010 (and was upheld by the Supreme Court in 2012), it included an "Unearned Income Medicare Contribution". This provision imposes an additional 3.8% tax on all net investment income including any profit on the sale of real estate held for investment, among other income. Whether or not it will apply to you depends on your income level. For individuals with income greater than $200,000 and married couples filing jointly with income greater than $250,000, this new provision applies and begins January 1, 2013.
A 1031 exchange can help you do two things related to this new 3.8% tax. If you meet the proper requirements of a 1031 exchange, you can defer the capital gains taxes that would be due on the sale of your property, along with the new 3.8% Medicare contribution and any potential depreciation recapture. Further, by not having to include the income from the sale of the property with other income you earn, it may keep you below the threshold for this new 3.8% contribution that might apply to your other income. In short, a 1031 offers you the ability to keep your equity working for you into the future---and is a more valuable tool than ever before.