Understanding and Avoiding Net Investment Income Tax (NIIT)

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Did you know that the federal income tax table isn’t a true picture of how much you pay in taxes? Your tax rates are based on many other factors that aren’t on the tables.

For example, you may owe net investment income tax (NIIT). This tax is 3.8% on top of your regular tax rate. Rental property owners are one group that pays this tax. It only applies to certain investors, but there are enough that it affects.

If your modified adjusted gross income (which is usually also your AGI) is more than $200,000 (single) or $250,000 (married filing jointly) and you have net investment income, you’ll pay it.

Your NIIT is 3.8% of your net investment income or the difference between the $200,000/$250,000 threshold and your MAGI, whichever is less.

Exceptions to the Rule

Fortunately, there are exceptions to the rule.

For example, if you are a real estate professional (this doesn’t just mean a real estate agent), you may be exempt. If your rental activity counts as a business in the eyes of the IRS, you can deduct your losses from non-rental income and potentially avoid NIIT.

To get status as a real estate professional, you must spend at least 50% of your time working on your real estate business AND have over 750 hours worked in the business for the tax year.

You must also prove you materially participate in the business. This is easy if you manage the properties yourself. Even if you don’t, but you put in at least 100 hours on the rental and no one else puts in more hours, you qualify.

Finally, your rental activity must be reported as a business on your tax returns. Most rentals qualify for this, but if you aren’t sure, I’m happy to help you make that determination.

You may also be exempt from NIIT if you only have short-term rentals. This means the average person rents for 7 days or less. This avoids the tax-code-defined business, but you can still deduct the losses if you materially participate in the rental.

One final ‘out’ is if you rent the property to yourself. In other words, if you the individual rents your property to you as a business, you don’t have to include the income in your net investment income.

I know it can be confusing, but we’re here to help you determine if you’re required to pay NIIT and/or how to get around it next year so you have more money in your pocket.