Is Installment Sale Income Subject to Net Investment Income Tax?

Higher earners, who meet certain thresholds, may be subject to the net investment income tax (NIIT). Those who have to pay the NIIT are slapped with a 3.8% tax on their net investment income or on the amount of modified adjusted gross income (MAGI) that exceeds the statutory threshold amount for your filing status. Basically, whichever of the two (investment income or MAGI) is the least amount will be subject to NIIT.

While MAGI usually affects high-income earners, it can also affect those with one-time income increases from the sale of stock, real estate, or a business — the topic of this article.

NIIT Thresholds

NIIT is applied to income on passive investments. If all of your income is from earnings, you will not likely be subject to NIIT. 

Per the IRS website, NIIT thresholds (including MAGI income over these amounts) are:

The above thresholds are not inflation-adjusted, which means they do not change from one year to the next.

NIIT uses IRS form 8960 titled Net Investment Income Tax— Individuals, Estates, and Trusts. From this form, some of the income sources that may be subject to NIIT include real estate, royalties, partnerships, s-corps, trusts, and the selling of stocks and bonds.

As mentioned above, NIIT targets passive income. If you are self-employed and own a partnership, you will likely not be subject to NIIT. However, if you are a passive investor in a partnership, NIIT will likely apply.

NIIT doesn’t apply to Social Security, distributions from qualified income accounts, wages, unemployment income, self-employment income, and alimony. 

Is Installment Sale Income Subject to NIIT?

An installment sale breaks up income from a sale and spreads it out over several years. Instead of realizing $100,000 in one year from a sale, the investor may realize $20,000 each year for five years. Less realized income from a passive investment sale during a year might reduce the chances that an investor hits NIIT thresholds.

To see how this works, let’s compare a regular investment sale to one that is done through an installment sale.

An investor who is married and filing jointly sells a passive investment for a profit of $30,000. Their MAGI is $300,000. The NIIT threshold for this investor is $250,000.

MAGI: $300,000

- NIIT threshold: $250,000

= $50,000

Passive income: $30,000

The 3.8% NIIT applies to the $30,000 since it is the lower of MAGI and the passive income. The tax due would be $1,140.

If we take the same tax filer but this time the investment is spread out over five years using an installment sale, we have:

MAGI: $300,000

- NIIT threshold: $250,000

= $50,000

Passive income: $30,000 / 5 = $6,000/yr

This time the tax filer will be taxed on $6,000 instead of $30,000. The tax savings are $1,140 - $228 ($6,000 x 3.8%) = $912. Of course, the $228 NIIT must be paid annually, but the tax impact is spread across five years instead of only one year.

So yes, an installment sale is still subject to the NIIT tax but can result in a much lower tax bill. However, everyone’s tax situation is unique, and the above are very generic examples. If you’re considering using an installment sale, it’s best to work with a tax accountant.