Understanding the NIIT for Rental Property Owners

If you are subject to the federal net investment income tax (NIIT), you could be paying as much as 3.8% more on your income taxes. Rental property owners are often subject to this additional tax, depending on their total income and how they structure their business.

Here are the two criteria the IRS uses to determine if you are required to pay NIIT:

1. Your modified adjusted gross income (MAGI) exceeds $200,000 for single filers, $250,000 for married filing jointly, or $125,000 for married filing separately; and
2. You have net investment income.

For NIIT purposes, your MAGI will likely be the same as your adjusted gross income (AGI). This is your gross income minus any above-the-line tax deductions. The federal tax code modifies the NIIT AGI only for certain U.S. citizens or residents who live abroad.

If you are subject to paying NIIT, you will pay 3.8% on the lesser of:

• Your net investment income; or
• The amount your MAGI exceeds the applicable income threshold.

NIIT Exemption for Real Estate Professionals

You may qualify as a real estate professional per the NIIT tax code. If you do, you will have some specific tax advantages:

• Deduct your losses from non-rental income; and
• Qualify to have your profits escape the NIIT.

The second tax advantage above may depend on if your rental activity qualifies as a business for tax purposes.

How to Earn Real Estate Professional Status

To qualify as a real estate professional, you or your spouse (if filing jointly) must spend over 50% of your work time in a real estate business or businesses. In addition, you mush spend over 750 hours working in real estate businesses during the year.

Rental Activity

In addition to being qualified as a real estate profession per NIIT tax codes, you must materially participate in your rental activity if you want to deduct your losses and/or qualify for the NIIT exemption. There are actually seven ways to establish your material participation. However, the two most common are:

1. Doing all the work to manage the rental; or
2. Working more than 100 hours on the rental (and more total hours than any other individual is working on the rental).

Rental Activity as a Business

Lastly, your rental activity must qualify as a business and not just a casual investment. This is per IRC Section 162. Most rental activities are considered businesses, even if reported on Schedule E. The legal tax definitions are somewhat vague, so consult with your tax advisor to make sure your rental activity qualifies as a business per NIIT regulations.

NIIT Exemption for Short-Term Rentals

Your rental property will be considered a short-term rental if the average tenant stay is less than seven days or when it is less than 30 days and you provide hospitality services such as cleaning or laundry. A short-term rental is exempt from the tax-law-defined real estate professional rules. You will need to materially participate in the property to deduct your losses on a short-term rental.

You will not be subject to NIIT on your short-term rental if you materially participate and the rental is a tax-code-defined business.

NIIT Exemption for Self-Rentals

Passive income from rental property that would otherwise be subject to the NIIT is recharacterized as non-passive if your rent the property to a business in which you materially participate. In other words, income from self-rentals is not included in the net investment income. Self-rentals can be tricky for tax purposes, so be sure to consult with your tax advisor.

To learn more about the NIIT and how it may affect your rental property income or other real estate investments, contact Illumination Wealth today.