Taxation and Real Estate Investment: Net Investment Income Tax

Written by Chris Norwood, NAI Norwood Group

We have all heard the bit about Death and Taxes. However a closer look into the tax code will reveal an interesting new tax that has been enacted in 2013. This new tax, on investment income, is often misunderstood as a result of it being misrepresented and also as a result of that it is downright confusing.  So here is a quick glance at what the new tax is and what it is not.

Net Investment Income Tax (NIIT):

IS NOT… a transfer tax – while you may end up paying the tax as a result of selling a property, it does not come out of the sales proceeds at the time of transfer.

IS NOT… just for real estate – all investment that you collect passively could be subject to this tax (rents, capital gains, stocks etc).

So what is the NIIT and what is taxable? The net investment income broadly speaking is a tax on passive income in the amount of 3.8%. However there are many thresholds and other factors.

Here is where it becomes a bit tricky to find out exactly how much of your income is subject to the tax. Using the words of the IRS, “The NIIT applies at a rate of 3.8 percent to certain net investment income of individuals, estates and trusts that have income above the statutory threshold amounts.” A table of all of the threshold amounts can be found: http://www.irs.gov/uac/Newsroom/Net-Investment-Income-Tax-FAQs.

What becomes taxable is the lesser of the amount of income over your threshold amount OR your Net Investment Income. Again quoting the IRS:

Taxpayer, a single filer, has $180,000 of wages. Taxpayer also received $90,000 from a passive partnership interest, which is considered Net Investment Income. Taxpayer’s modified adjusted gross income is $270,000.

Taxpayer’s modified adjusted gross income exceeds the threshold of $200,000 for single taxpayers by $70,000. Taxpayer’s Net Investment Income is $90,000.

The Net Investment Income Tax is based on the lesser of $70,000 (the amount that Taxpayer’s modified adjusted gross income exceeds the $200,000 threshold) or $90,000 (Taxpayer’s Net Investment Income). Taxpayer owes NIIT of $2,660 ($70,000 x 3.8%).

Logistics of the law aside, where this can really come into play are one time large gains yielded form the sale of a building. For investors with smaller portfolios and personal income well below the threshold amounts, this may not affect them; however for investors selling a property with a low basis, the tax could be triggered.

It is important that all investors talk with their accountants prior to selling a property to understand the tax ramifications. However we advise you also to discuss with your accountants the tax liabilities from you passive rents as well to understand the full effects this tax may carry.