Net Investment Income Tax

The net investment income tax (NIIT) is a 3.8% federal surtax, enacted as part of the Affordable Care Act and codified in Section 1411, that applies to certain investment income of higher-income taxpayers. It is levied on the lesser of the taxpayer's net investment income or the amount by which their modified adjusted gross income exceeds a threshold, which is $200,000 for single filers and $250,000 for married couples filing jointly (these thresholds are not indexed for inflation). Net investment income includes interest, dividends, capital gains, rental and royalty income, and income from passive business activities; it generally does not include income from a trade or business in which the taxpayer materially participates, or self-employment income already subject to other Medicare taxes. For real estate investors, the NIIT is significant because the capital gain from selling an appreciated property, as well as net rental income, can be subject to the additional 3.8%, stacking on top of the regular capital gains and depreciation recapture taxes and pushing the effective rate higher. Deferral strategies such as a 1031 exchange postpone recognition of the gain and therefore the associated NIIT, while a step-up in basis at death can eliminate it on the unrecognized appreciation. Real estate professionals who materially participate in their rental activities may, in some circumstances, treat the income as non-passive and outside the NIIT, a fact-specific determination best confirmed with a tax advisor.