Net Investment Income: What Is It and How Is It Taxed?

Net Investment Income: What Is It and How Is It Taxed?

What Is Net Investment Income?

Net investment income, or NII, is income generated from investments after subtracting related expenses, such as interest payments on loans used to finance acquisitions, brokerage fees, and other investment costs.

Some common examples of net investment income sources include:

  • Capital gains from the sale of stocks, bonds, mutual funds, and real estate
  • Dividends from stocks and mutual funds
  • Interest from bonds, certificates of deposit (CDs), and savings accounts
  • Passive income
  • Rent from properties
  • Royalties from copyrights and patents

Is the Sale of a Home or Personal Residence Included in Net Investment Income?

Money made from the sale of a home may or may not be included in net investment income depending on tax status, how long the house was owned, and profit from the sale. In some sale situations, primary residences may be eligible for exclusions or deductions from taxable income under the IRC’s “principal residence tax exclusion.”

This IRS tax code for principal residence exclusion allows individuals to have a portion of the capital gains from a primary home exempt when they meet specific ownership criteria.

When the profit from selling a principal residence qualifies for a tax exclusion, it is generally not considered net investment income. If the profit exceeds the principle residence exclusion limits, or the property was not the main home, the home may be considered a taxable net investment income source.

How Do You Use Form 8960 to Calculate Net Investment Income?

Form 8960 helps you determine how much net investment income tax (NIIT) you owe, if any. After calculating your modified adjusted gross income (MAGI), you can deduct and exclude other sources of income, such as retirement account distributions or tax-exempt interest.

Once you add up all your net investment income, you apply NIIT rates according to your filing status.

Other items excluded from net investment income include wages, alimony, unemployment compensation, social security benefits, and income subject to estimated or self-employment taxes.

You can find form 8960 and instructions on how to calculate NII taxes at

What Is Net Investment Income Tax?

Established as part of the Affordable Care Act in 2013, net investment income tax was designed to help fund provisional aspects of the ACA. NIIT targets higher-income taxpayers with significant investments to ensure part of an individual’s investment income goes toward ACA expenses for healthcare expansion and availability.

Individual taxpayers must pay 3.8% net investment income tax on the lowest amount between their net investment income or MAGI that exceeds the statutory threshold assigned to an individual’s filing status.

As of this writing, the MAGI threshold amounts for NIIT are:

  • Married filing separately MAGI: $125,000
  • Married filing jointly MAGI: $250,000
  • Single or head of household MAGI: $200,000
  • Qualifying widow/widower with a child MAGI: $250,000.

Will You Owe NII Taxes Simply for Having Any Investments?

NIIT applies only to certain types of investment income, such as interest, dividends, capital gains, rental income, royalties, and some passive income. Not all investment income is subject to net investment income tax.

For example, tax-exempt interest and distributions from retirement accounts like IRAs or 401(k)s are generally not included in net investment income subject to NIIT.

Taxpayers with MAGIs below their filing status threshold generally won’t owe NII taxes. In addition, if you are eligible to take NII exclusions and deductions, you may reduce your net investment income subject to NIIT.

For instance, a taxpayer can exclude primary residence gains and deduct investment interest expenses if they qualify.

How Does MAGI Affect Net Investment Income?

MAGI determines whether your income is higher than the preset thresholds that trigger NIIT. If your MAGI amount exceeds your filing status threshold, you may owe net investment income taxes to the IRS.

Remember that the NIIT tax rate of 3.8% applies only to the lower of your net investment income or your MAGI amount that exceeds your filing status threshold. Deductions from your MAGI may reduce investment income subject to NIIT.

Contributions to retirement accounts like traditional IRAs or 401(k)s can also reduce your MAGI and lower NIIT liability.

Understanding how MAGI impacts net investment income may improve tax planning strategies to minimize NIIT tax liability.

These strategies might involve timing capital gains or losses, maximizing deductions, contributing to tax-advantaged retirement accounts, or exploring investment options that generate tax-exempt income.

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