Net Investment Income Tax (3.8%) for Early Retirees

By Tom, CPA · Updated October 25, 2026

TL;DR: The net investment income tax is an extra 3.8% on the smaller of your net investment income or the amount your modified AGI exceeds $250,000 (joint), $200,000 (single or head of household) or $125,000 (married filing separately). The thresholds are not indexed for inflation.

Educational only, not tax, legal, or investment advice. Examples are illustrations, not predictions. Rules and limits change; verify current figures and talk to a qualified professional about your situation.

A 3.8% surtax with thresholds frozen since 2013. Inflation sends its regards. The net investment income tax (NIIT) was designed to hit high earners, and for most early retirees living on $60,000 to $120,000 a year it never applies. It shows up in specific years: the year you sell a rental, a business or a concentrated stock position, or the year you do a very large Roth conversion on top of a big taxable portfolio.

Because the thresholds are not adjusted for inflation, more households cross them every year. This guide covers what counts, how the calculation works and how to plan around it.

CPA Warning Label: Roth conversions and IRA withdrawals are not investment income, but they raise MAGI, which can drag your dividends and gains into the 3.8% tax.

What NIIT applies to

According to IRS Topic 559, net investment income generally includes:

• Interest, dividends, capital gains, rental and royalty income, and non-qualified annuity income.
• Income from businesses that are passive activities to you, and businesses trading financial instruments or commodities.
• Gains from selling stocks, bonds, mutual funds, investment real estate and second homes, and interests in passive partnerships and S corporations.

It generally does not include wages, self-employment income, Social Security benefits, tax-exempt interest (such as municipal bond interest), distributions from qualified retirement plans and IRAs, or the excluded part of gain on selling your main home.

For early retirees, the key exclusions are IRA and 401(k) distributions and Roth conversions. They are not investment income. But they count in MAGI, which is the other half of the formula.

Unindexed thresholds

These amounts are written into the statute and are not adjusted for inflation (IRS Topic 559). Compare that with the 2026 ordinary brackets and capital gains bands, which rise every year. Over time, the NIIT reaches further down the income scale.

Notice that the single threshold is not half the joint one. A married couple is penalized relative to two single people, and a surviving spouse moves from a $250,000 threshold to $200,000 after the qualifying surviving spouse years end.

Calculation with Form 8960

NIIT equals 3.8% times the smaller of:

1. Net investment income (investment income minus allocable deductions such as investment interest and state tax on investment income), or
2. MAGI minus the threshold.

For most people, MAGI is just AGI. It is computed on Form 8960 and added to your tax on Schedule 2. NIIT is also included in estimated tax calculations, so a big sale year needs bigger estimated payments (see estimated taxes).

Illustration. Assumptions: married couple filing jointly, 2026. Income: $150,000 Roth conversion, $40,000 of qualified dividends, $90,000 of long-term capital gains. MAGI is $280,000.

• Net investment income: $130,000.
• MAGI over threshold: $30,000.
• NIIT: 3.8% × $30,000 = $1,140.

Without the conversion, MAGI would be $130,000 and NIIT would be zero. The conversion itself was not taxed by NIIT, but it caused $1,140 of NIIT on investment income. That is part of the true cost of converting.

Rental income and NIIT

Rental income is generally net investment income unless it comes from a trade or business in which you materially participate, or you qualify as a real estate professional and meet the related tests. For most early retirees with a few rentals, net rental profit is investment income, and so is the gain when a rental is sold.

The sale year is the danger zone. Selling a rental with $300,000 of gain puts the whole gain into both MAGI and net investment income, often triggering NIIT on much of it, on top of capital gains tax and up to 25% on unrecaptured section 1250 gain from depreciation (IRS Topic 409). Spreading the gain with an installment sale, or offsetting it with harvested losses, can reduce the hit.

Planning around it

• Avoid stacking a big Roth conversion in the same year as a big capital gain. Put them in separate years.
• Use municipal bonds for fixed income in taxable accounts if you are near the threshold; tax-exempt interest is excluded from NIIT (see municipal bonds).
• Harvest losses to offset gains in high-income years, which reduces both net investment income and MAGI.
• Give appreciated shares to charity instead of selling them.
• Hold investments to death where possible; heirs generally receive a basis step-up.
• Watch the survivor threshold drop from $250,000 to $200,000.

Who is likely to owe it

NIIT mostly affects early retirees in a few predictable situations: a one-time large sale, a very large taxable portfolio with high dividends, a big Roth conversion year combined with investment income, or the final working year when wages are still high and a severance or bonus lands. In a normal early retirement year with spending around $100,000, most households will be well under the thresholds.

Lavish Larry once sold his entire stock portfolio in December to buy a boat, triggering NIIT, the 15% capital gains rate and a lost ACA subsidy in one move. The boat is called Form 8960.

Second illustration: the survivor threshold

Illustration. Assumptions: a widow, filing single in 2026, after the qualifying surviving spouse period has ended. Income: $70,000 RMD from an inherited IRA, $40,000 of Social Security (85% taxable, $34,000), $60,000 of qualified dividends and interest from a large taxable account, and a $50,000 long-term gain from rebalancing.

• MAGI: $70,000 + $34,000 + $60,000 + $50,000 = $214,000.
• Net investment income: $110,000.
• MAGI over the $200,000 single threshold: $14,000.
• NIIT: 3.8% × $14,000 = $532.

Filing jointly with the same income, she would have been $36,000 under the $250,000 threshold and owed no NIIT. The fix might be as simple as deferring part of the rebalancing gain to January or shifting some taxable bonds to municipal bonds.

NIIT and the 0% capital gains band

These two rules rarely collide. The 0% capital gains band ends at $98,900 of taxable income for joint filers, while NIIT does not start until $250,000 of MAGI. A household using the 0% band is nowhere near NIIT. The two become relevant together only for higher-income households in the 15% band, where a large sale can produce an effective 18.8% federal rate on gains (15% plus 3.8%).

Deductions that reduce net investment income

Form 8960 lets you subtract expenses properly allocable to investment income, such as investment interest expense, certain state and local income taxes attributable to investment income, and some investment-related costs. For many retirees these deductions are small, especially after the limits on miscellaneous itemized deductions. Rental expenses, including depreciation, reduce net rental income before it reaches Form 8960, which is one more reason good rental records matter.

Capital losses also reduce net investment income, but only to the extent they offset gains; the $3,000 ordinary loss deduction does not create negative investment income beyond that.

State versions

A few states have their own taxes on investment income or treat it differently, and most states simply tax investment income as ordinary income. NIIT is federal only. Check your state's rules separately before a large sale.

Quick math check

A shortcut for estimating NIIT in a planning year: take the smaller of your expected investment income or how far your MAGI is over the threshold, multiply by 0.038. If both numbers are positive and the result is under a few hundred dollars, a small change in timing (deferring a sale to January, or spreading a conversion over two years) might eliminate it. If the result is large, it is worth modeling the year carefully before acting.