New IRS Rules for Rental Property Owners – Avoid the 3.8 Percent Obamacare Tax

           Rental Property Owners can Avoid the 3.8 Percent Obamacare Tax

An achievement of the Obama administration has been the 2010 Affordable Care Act, a.k.a. Obamacare. Part of the law is a 3.8%    investment income surtax that will be applied to “high-income” earners beginning in 2013. Recently, the IRS issued NEW regulations that offer a possibility for rental property owners to avoid the 3.8% Obamacare tax.

Those who are subject to this 3.8% tax on investment income, including rental income, are also subject to this tax on the profits after selling the rental property.

New IRS rules have created a way to avoid the Obamacare tax.  The following techniques apply not only to last year but also this year   and future years.



Start with obtaining tax law status as a Real Estate Professional – this  is a person who qualifies as being in a real estate trade or business for tax purposes.

Those who own rental property and have rental property tax losses will want to qualify as a real estate professional so that deductions of rental losses can be applied against business and portfolio income. Now, with the new IRS rules, qualifying as a Real Estate Professional can assist with avoiding tax on investment profits.

According to the NEW IRS REGULATIONS, qualifying as a Real Estate Professional AND participating in rental real estate activities for more than 500 hours during the year contain the ability to deem rental real estate as “trade or business property” which is exempt from the 3.8% tax.

Consult your tax professional to learn what is needed to qualify for Real Estate Professional status. Having the designation of Real Estate Professional as a tax status means that

·         Your rental real estate profits are exempt from the 3.8% tax, and

·         Gain on sale of those rental real estate properties is exempt from the 3.8% tax



The 3.8% tax applies to investment income, not business income. Rental property is generally considered passive by nature. However, Rental real estate can qualify as Section 162 trade or business property despite reporting it as rental property on Form 1040, Schedule E. When rental property qualifies as a trade or business property it avoids the 3.8% Obamacare tax – only if that property or group of properties is not a passive trade or business. In most cases, this will require qualification as a Real Estate Professional.


Qualifying as business property avoids the 3.8% tax and also qualifies for

·         Tax-favored Section 1231 treatment

·         Business use of an office in your home

·         Business (versus investment) treatment of meetings, seminars, and conventions, and

·         Section 179 treatment on your business-use assets


Please Note: The Real Estate Professional status is a designation given by the IRS based on the number of hours that you work in real estate activities versus other activities. Rental property owners requesting Real Estate Professional status on tax returns will likely be challenged by the IRS by requiring proof of qualifications. Consult your tax professional to learn what is needed to qualify for Real Estate Professional status. Examine your rental property with your Tax Professional to see if it qualifies as trade or business property.


Steven Z. Freeman, CPAprovides Tax Planning and Business Accounting and can assist you with these services. If you have any questions on this matter, or to schedule an initial consultation, Please call us at (805) 495-4211.

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