Is Rental Property Subject to Net Investment Income Tax (NIIT)?

Net rental income is subject to net investment income tax, or NIIT, but only on a portion of your modified adjusted gross income above certain thresholds. Additionally, gain from the sale of rental property may also be subject to NIIT unless the rental activity is part of an active trade or business.

Created as part of the Health Care and Education Reconciliation Act of 2010, NIIT was included as a revenue-raising tool in order to offset the costs of the Affordable Care Act.

Even if you owe NIIT on your rental property income, there are ways to potentially reduce your income tax liability.

What is the Net Investment Income Tax?

Under Section 1411 of the Internal Revenue Code, Net Investment Income Tax is a 3.8% surtax that applies to certain net investment income, such as interest, dividends, royalty income, non-qualified annuities, capital gains, and income from rental property. NIIT can apply to individuals, estates, and trusts that have income above a certain threshold amount.

The statutory threshold amounts are:

• Married filing jointly — $250,000,
• Married filing separately — $125,000,
• Single or head of household — $200,000
• Qualifying widow or widower with a child — $250,000

This applies to income acquired from a trade or business that classifies as passive income, including income from business trading financial instruments or commodities.

How the Net Investment Income Tax Works

NIIT depends on your modified adjusted gross income (MAGI). This can be defined as your household’s adjusted gross income, including any tax-exempt interest income and certain deductions.

If you generate income from your rental property and your MAGI exceeds the thresholds listed above, then the 3.8% will apply to your net investment income or the portion of your MAGI that goes over the threshold, whichever is less.

Here are two examples:

1. You made $25,000 in net income from your rental property and your MAGI goes over the threshold by $50,000. You’ll owe the 3.8% tax on the $25,000 from the rental property because it is less than the overage.
   
   .038 x $25,000 = $950 owed
2. You made $40,000 in net income from your rental property and your MAGI goes over by $10,000. You will owe the 3.8% tax; however, it will be on the $10,000 since it’s less than your net investment income.

.038 x $10,000 = $380 owed

Do I Need to Pay the Net Investment Income Tax on My Rental Property?

If your income is above the statutory threshold amount, then yes, you would owe the 3.8% NIIT. However, there are ways you can potentially reduce your MAGI, such as:

• Increase tax deductions - By making a large donation or claiming unreimbursed business expenses, mortgage interest expenses, or loan origination fees, you could lower your modified adjusted gross income.
• Increase HSA contributions - Making contributions to an HSA-qualified high-deductible health plan could reduce your MAGI.
• Decrease or delay income - If you can delay receiving income or increase capital losses, you might be able to claim a lower MAGI for the current tax year. 

However, if you do owe NIIT from your rental property, you must file IRS Form 8960 with your tax return and you must make quarterly estimated payments on the amount you think you'll owe, as well as any quarterly income payments.