The NIIT is a 3.8% income tax on unearned income (income other than from a job or business). It was implemented with the passing of Obamacare.
Net rental income is subject to the NIIT and so is the capital gain on the sale of rental property.
Your unearned income is subject to the NIIT if your AGI exceeds $200k if single and $250k if married filing joint. If the gain from the sale of a rental pushes you over the above thresholds, part of the gain will be subject to an additional 3.8% tax.
The Net Investment Income Tax (NIIT) essentially raises the top capital gain tax bracket from 20% to 23.8%.
Net investment income includes:
- Income from investment assets including rents, dividends, interest and annuities
- Income from any business in which you don’t materially participate including real estate syndications and funds
- Net capital gains earned upon the sale of property that is not part of an active business, including rental property, stocks and bonds, and mutual funds.
Net investment income does not include:
- Income from a business in which you materially participate, self-employment income, and W-2 wages earned
- Income from tax-exempt bonds
- Capital gain from selling a primary residence when you qualify for the Section 121 Exclusion
- Income from renting your home out for now more than 14 days during the year
- Withdrawals from retirement plans such as traditional or Roth IRAs, 401(k)s, or payouts from traditional defined-benefit pension plans
- Life insurance proceeds, veterans’ benefits, Social Security benefits, alimony, or unemployment benefits.
If you qualify as a real estate professional, demonstrate material participation, and your rentals qualify a business, your positive rental income will be excluded from the NIIT.
With the passing of NIIT, a safe harbor was passed that allows a real estate professional who devotes more than 500 hours per year
to the rental activity to automatically qualify the activity as a business. Additionally, if a real estate pro has participated in rental real estate activities for more than 500 hours per year in five of the last ten tax years, the rental activity will qualify as a business. (IRS Reg. § 1.1411-4(g)(7).)
