The income you make from passive investments on your trust or estate, minus any accrued expenses, is your Net Investment Income (NII). This number is added into your Adjusted Gross Income (AGI) and determines how you are taxed according to Section 1411 when tax season rolls around.
To make sure you are retaining as much of your NII as possible, it is important to explore what a Section 1411 Adjustment is, how it is calculated, how Net Investment Income Tax (NIIT) works, and how a 1031 Exchange can help you avoid paying the NIIT and hold onto your investment income.
What Is a 1411 Adjustment?
A 1411 Adjustment is any changes or reports made to your NII information. NII is all your income from passive investment sources such as stocks, rentals, bonds, or investment properties. The NIIT rate is determined by the type of investment income you received, such as dividend income, interest income, or capital gains. These include investment income you earned on:
- Stocks
- Bonds
- Dividends
- Investment income
- Estates and trusts
- Other passive income
How Do You Calculate a 1411 Adjustment?
Your 1411 adjustments are calculated by adding up all your investment incomes and subtracting any expenses you incurred when earning the income. For instance, if you sell an investment property, you take the amount you sold the property for and subtract your real estate agent fee, marketing fees, inspection fees, or other expenses. The resulting amount would be your NII on that sale. If you have several such transactions, you would simply add the NII of each together to reach your total NII.
Net Investment Income Tax
In 2013, the IRS began imposing a tax on investment income that reaches a certain threshold. The NIIT rate starts at 3.8% for individuals with an NII between $125,000 to $250,000 and includes those with an Adjusted Gross Income (AGI) at these thresholds who have estates or trusts with undistributed NII.
Your tax rate is determined by your AGI or Modified Adjusted Income (MAGI). What is important to keep in mind is that the lower your AGI or MAGI, the less NIIT liability you have toward the IRS.
Why You Should Consider a 1031 Exchange
A 1031 Exchange is a real estate investment transaction. During a 1031 Exchange, you sell your real estate investment property and move it into a like-kind investment, typically another piece of real property. This means that you delay receiving capital gains, but you keep the investment so you can access it at another time.
This is an option if you are worried about NIIT. Capital gains add to your AGI, so you can avoid adding to your AGI when you have a 1031 Exchange plan in place. This can help manage your NIIT liability.
Explore Your Section 1411 Options
When it comes to Section 1411, there are many adjustments you can make to hold on to as much of your NII as possible. A 1031 Exchange is one way to manage your NIIT burden and use your NII in a way that can benefit you and your family.
This material is for general information and educational purposes only. Information is based on data gathered from what we believe are reliable sources. It is not guaranteed as to accuracy, does not purport to be complete and is not intended to be used as a primary basis for investment decisions. It should also not be construed as advice meeting the particular investment needs of any investor. Realized does not provide tax or legal advice. This material is not a substitute for seeking the advice of a qualified professional for your individual situation. The income stream and depreciation schedule for any investment property may affect the property owner’s income bracket and/or tax status. An unfavorable tax ruling may cancel deferral of capital gains and result in immediate tax liabilities. Costs associated with a 1031 transaction may impact investor’s returns and may outweigh the tax benefits. The actual amount and timing of distributions paid by programs is not guaranteed and may vary. There is no guarantee that investors will receive income, distributions or a return of their capital. All real estate investments have the potential to lose value during the life of the investment.
