How NIIT applies to rental property owners

The Net Investment Income Tax (NIIT) is a 3.8% tax that applies to the lesser of:

  • Your net investment income for the year, or
  • The excess of your modified adjusted gross income (MAGI) over the NIIT threshold.

As of 2025 the statutory MAGI thresholds remain:

  • $200,000 for single filers (and married filing separately),
  • $250,000 for married filing jointly,
  • $125,000 for married filing separately (applies when married filing separately),

(See IRS Topic No. 559 and Form 8960 instructions for full details.) https://www.irs.gov/taxtopics/tc559 https://www.irs.gov/forms-pubs/about-form-8960

Because NIIT is based on MAGI and net investment income, rental property owners with significant rental profits, appreciated property sales, or other investment income (interest, dividends, capital gains) can see an additional 3.8% applied to part of that income.

What counts as “net investment income” for rentals?

Net investment income generally includes income from passive activities (like most rentals), interest, dividends, royalties, and capital gains. For rental owners that typically means:

  • Gross rental receipts (less allowable rental expenses),
  • Gains from selling rental property,
  • Any passive partnership or S‑corp K‑1 income tied to real estate,
  • Investment interest and dividends unrelated to an active trade or business.

However, there is an important exception: if the rental activity rises to the level of a trade or business and you materially participate (or you qualify as a real estate professional under tax rules), then that rental income may not be treated as net investment income for NIIT purposes. The Form 8960 instructions and IRS guidance describe when rental activity is excluded from NIIT because it is part of a trade or business in which the taxpayer materially participates. https://www.irs.gov/forms-pubs/about-form-8960

In practice I’ve seen many investors assume all rental income is automatically exempt from NIIT if they run their properties through an LLC. That’s not correct — entity form alone doesn’t change whether income is ‘‘investment’’ or ‘‘business’’ for NIIT; the facts about participation and the nature of the activity matter.

How NIIT is calculated — simple step example

Step 1 — Compute MAGI (your AGI plus certain modifications). For most taxpayers MAGI for NIIT equals AGI with limited adjustments; consult Form 8960 instructions.

Step 2 — Compute net investment income (total investment gross income minus investment expenses and allowable deductions tied to that income).

Step 3 — Compute the excess MAGI amount over the threshold (e.g., MAGI − $250,000 if married filing jointly).

Step 4 — NIIT = 3.8% × lesser of (net investment income, excess MAGI)

Example:

  • Married filing jointly: MAGI = $260,000
  • Net investment income (rental + capital gains) = $80,000
  • Excess MAGI = $260,000 − $250,000 = $10,000
  • NIIT applies to the lesser of $80,000 and $10,000 → $10,000
  • NIIT = 3.8% × $10,000 = $380

That example illustrates a common outcome: if your MAGI is only slightly above a threshold, you’re only taxed on that excess, even if total investment income is larger.

Key rental-specific rules and pitfalls

  • Passive activity vs material participation: Most rental income is passive and therefore part of net investment income. But if you qualify as a real estate professional and materially participate in the rental trade or business (meeting IRS tests), rental income may be excluded from NIIT. This is a facts-and-circumstances determination — document hours, duties, and responsibilities if you plan to claim material participation.

  • Depreciation and passive loss rules: Depreciation reduces taxable rental income, which lowers net investment income for NIIT. But passive activity loss limitations and special allowances (like the $25k active participation offset for real estate) can affect how much loss you can use in the year.

  • QBI (Section 199A) deduction: The qualified business income (QBI) deduction is separate from NIIT. QBI may reduce taxable income but does not always reduce MAGI used for NIIT calculations; don’t assume a QBI deduction will eliminate NIIT exposure without running the numbers.

  • Installment sales and timing: Spreading gain from a property sale over multiple years via installment sale can help keep MAGI under the threshold in any one year and reduce NIIT exposure.

  • State taxes: NIIT is a federal surtax; many states have their own taxes on investment income or capital gains — plan for both federal NIIT and state tax consequences.

Practical planning strategies for rental owners

  1. Track participation and consider qualifying as a real estate professional (if you legitimately meet the tests). Becoming a real estate professional can remove rental income from NIIT if you materially participate. This requires careful documentation — hours worked, types of services, and contemporaneous logs.

  2. Use depreciation and cost segregation. Accelerating depreciation or using cost segregation studies can create or increase paper losses that reduce net investment income in the short run, lowering NIIT exposure. This can be powerful after acquisition or renovation.

  3. Time property sales and capital gains. If possible, structure sales in years when MAGI is lower or use installment sales to spread gain across tax years.

  4. Harvest tax losses elsewhere in the portfolio. If you hold taxable securities, realize losses to offset gains; reduced net investment income will reduce NIIT exposure.

  5. Review entity and compensation structures carefully. Shifting compensation to wages or converting passive holdings into an active business (with payroll and demonstrated material participation) can change NIIT treatment — but entity changes can create other tax or legal consequences, so run projections.

  6. Consider charitable strategies. Donor-advised funds or gifting appreciated property to charity can reduce taxable gains and investment income in a year of high MAGI. (Don’t rely on charitable giving as a primary NIIT avoidance tactic without guidance.)

  7. Coordinate AMT and phaseouts. NIIT interacts with other surtaxes and phaseouts (e.g., Medicare surtax on wages, Alternative Minimum Tax considerations). See our guide on planning for AMT and NIIT for more detail: Planning for AMT, Net Investment Income Tax and Phaseouts.

Example scenarios (realistic illustrations from client work)

Case A — High rental income, low other income:

  • Single investor: AGI $210,000, rental net income $50,000 → excess MAGI = $10,000 → NIIT applies to $10,000 → NIIT = $380. The investor’s total rental income didn’t all trigger NIIT because MAGI only slightly exceeded the threshold.

Case B — Large capital gain from sale of rental:

  • Married filing jointly: MAGI before gain = $230,000, capital gain on sale = $180,000 → combined MAGI = $410,000 → excess MAGI = $160,000. If net investment income is $180,000, NIIT applies to the lesser ($160,000) producing NIIT = 3.8% × $160,000 = $6,080.

Case C — Real estate professional:

  • Taxpayer qualifies as a real estate professional and materially participates in an operating rental business. Much of the rental net income may not be subject to NIIT because it’s treated as active trade or business income (confirm with Form 8960 rules and your tax advisor).

Required filing and forms

If you owe NIIT you calculate it on IRS Form 8960, Net Investment Income Tax — Individuals, Estates, and Trusts. Information from Form 8960 flows to your individual return (Form 1040). Always follow current-year instructions; the IRS maintains Topic No. 559 and Form 8960 guidance online. IRS Topic No. 559 — NIIT Form 8960 info

Also consider our article covering NIIT on property sales for more detailed sale-specific examples: Net Investment Income Tax (NIIT) on Real Estate Sales.

Common mistakes to avoid

  • Treating LLC or S‑corp formation as an automatic NIIT fix. Entity selection doesn’t by itself change NIIT classification — participation and business facts do.

  • Forgetting to include other income when estimating MAGI. Salary, bonuses, retirement distributions, and taxable Social Security can push MAGI over thresholds.

  • Overlooking the timing of expenses and income. A large sale late in the year can create unexpected NIIT liability unless you plan timing or use an installment method.

Next steps and recommendations

  • Run a projected tax calculation for the current year including projected rental income, expected sales, and other income to see whether you cross the NIIT thresholds.

  • Talk with your CPA or tax advisor about material participation tests, cost segregation, timing strategies, and whether an installment sale or other structuring can reduce NIIT liability.

  • Read our related resources for deeper guidance: the general NIIT overview and sale-specific article linked above, and our broader tax planning pieces.

Sources and further reading

Additional FinHelp resources:

Professional disclaimer

This article is educational and informational only and does not constitute tax, legal, or investment advice. Tax law is complex and fact-specific; consult a qualified tax professional before making decisions that affect your tax position.

Author note: In my practice I routinely model NIIT scenarios when clients consider selling rental property or accelerating renovations — even a modest excess of MAGI over the threshold can change after‑tax outcomes. Detailed projections and documentation (especially for material participation) are the best defenses to unexpected NIIT bills.