As part of the financing of Obama Care, Congress created Internal Revenue Code Section 1411, which created a new 3.8 percent Medicare tax. The new Medicare tax will take effect on January 1, 2013, and will apply to net investment income of individuals with a modified adjusted gross income of at least $200,000 ($250,000 for couples filing jointly). The tax will apply to the lesser of (1) the taxpayer’s total “net investment income” for the year, or (2) the amount by which the individual’s total income exceeds $200,000 (or $250,000 for married couples filing jointly). This new tax will hit real estate investors hard.

Investment Income Includes Rental Income 
Under the new code provision, “net investment income” is defined to include “gross” rents. Even though “gross” rents are subject to the new Medicare tax, the “gross” rents can be reduced by deductions properly allocable to the rents. We expect that this will allow an individual to deduct depreciation, interest expense, property taxes, insurance payments, and other rental property expenses before determining the amount of “gross” rents subject to the new Medicare tax (although it does cause concern that Congress used the term “gross rents,” if it is actually intended to mean “net” rents).

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