How Does The Net Investment Income Tax Apply To Rental Real Estate?

Taxpayers should be careful that their local rental income may be at the mercy of taxes in addition to normal income tax. What is the web Investment Income Tax? The Net Investment Income Tax (NIIT) is a surtax that required impact in 2013. The NIIT was designed to boost tax income from Medicare payroll taxes on received income by broadening its reach to unearned investment income. The NIIT only applies to certain high-income taxpayers. 250,000 (joint filers) are subject to the surtax on investment income that surpasses the thresholds. Remember that these amounts are not indexed for inflation. NIIT imposes a 3.8% surtax on income from investments. Investments includes stock portfolio income items such as interest, dividends and short-term and long-term capital benefits.

Royalties, local rental business and income income from activities that are treated as passive are also at the mercy of the surtax. Read my post on passive activities in rental real estate for more information. It’s quite common for recipients of local rental income, such as taxpayers who own local rental properties straight or through pass-through entities (partnerships, LLCs or S Corporations), to also be involved with the business procedures conducted on the property. The normal scenario is a business owner that owns the real estate in which he operates also.

The real estate is in a separate entity that gathers rents from the operating entity. Have a look at my prior post on IRS guidelines for self-rentals for more information. The NIIT is intended to use to unaggressive investment income, than income produced from an active trade or business rather. Therefore, it ought never to penalize a taxpayer who separates its real property from business operations.

This was clarified within an Internal Revenue Bulletin that managed to get clear that, if a person derives rental income from an ongoing business activity where the individual is materially taking part, the 3.8% taxes won’t apply. Does the surtax apply to real estate specialists? While losses from real estate activities are passive per se, the losses of a real estate professional are considered ordinary losses and open to offset other ordinary income. Net rental income is generally included in the calculation of NIIT and is therefore subject to the 3.8% surtax. If all three of the conditions are fulfilled, the income from the rental real estate activity can be excluded from the calculation of online investment income.

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What about sales of real property? Gains from the disposition of property (other than property held within an energetic trade or business) is at the mercy of NIIT, including gain on the sale of shares, bonds, mutual money and real estate. The gain from the sale of local rental property is also subject to NIIT unless the local rental activity is part of a dynamic trade or business.

If the real estate activity is considered a unaggressive activity, any gain on the sale of property would create gain that would be subject to the web investment tax. However, if the taxpayer qualifies as a real estate professional, and the activity is considered a dynamic trade or business, any gain on the sale of the property may be exempt from the web investment tax. The characterization of the house for purposes of taxation of the gain on disposition is set based on the treating the house during its operation.

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