As I have mentioned in past columns, the traditional capital gains tax is not the only levy imposed on your taxable gain when you sell an appreciated asset like property or a business.
One of the newer taxes on your investment gains is the Net Investment Income Tax (NIIT), which tacks on 3.8% to your tax bill for the year you receive the sale proceeds (the actual cash) when you have sold an asset, such as real estate. Passed into law in 2013 during the Obama Administration as part of the Affordable Care Act (to help pay for it,) this tax charge is in addition to the more widely known capital gains tax that most people expect to pay.
It is important to understand exactly what net investment income is eligible for this tax.
What makes up Net Investment Income?
Generally, you can consider these types of income eligible for the NIIT:
- Interest earned on assets
- Dividends received
- Capital gains on assets sold
- Rental and royalty income
- Non-qualified annuities
- Income from businesses involved in trading of financial instruments or commodities
- Income from businesses that are “passive activities to the taxpayer,” for example a business you own a share of, but in which you do not actively participate.
Capital gains, for instance, come in all sorts of flavors, but these are commonly included as income when calculating the NIIT:
- Gains from the sale of stocks, bonds, and mutual funds.
- Capital gain distributions from mutual funds
- Gain from the sale of investment real estate, including second homes
- Gain on sale of primary residence above the allowed Homeowners Exclusion
- Gains from the sale of interests in partnerships and S corporations (to the extent the partner or shareholder was a passive owner).
How is the Net Investment Income Tax determined?
To illustrate, let’s say your gross income for this tax year is $150,000 and you have a taxable gain from the sale of an investment property of $80,000. Adding the two together, your adjusted gross income totals $230,000.
After determining your Adjusted Gross Income, subtract from it the appropriate threshold amount for how your file your tax returns:
|Filing Status||Threshold Amount|
|Married filing jointly or Qualifying widow(er)||$250,000|
|Married filing separately||$125,000|
|Single or Head of household||$200,000|
If, for example, you file as a single individual, you can deduct the $200,000 threshold amount, leaving $30,000 that is subject to the Net Investment Income Tax at 3.8%. This is how the taxes would be portioned out:
|Subject to Capital Gains Tax||
|The entire taxable capital gain is taxed at 20%|
|Subject to NIIT||$30,000||$1,140||Only the capital gain above $200,000 is taxed at the additional 3.8%|
(Note: For the purposes of this example we are simplifying by excluding other federal and state taxes that may apply)
At TaxWealth, we ask a lot of questions of each client we serve. It is important to do this because the answers we get many times lead to discovering unclaimed deductions that were available to them but about which they were completely unaware. That results in them keeping tens of thousands of dollars or more in their pockets instead of giving it needlessly to the tax man.
The tax code is a complicated collection of moving parts that sometimes work against each other. Sorting out how to turn the gears so that they mesh favorably for you takes expert help. Call us before you sell your appreciated asset so that you can tap into the expertise needed to grease the gears properly and pull the right levers to keep your tax bill under control.