NIIT on rental income: when the 3.8% applies

By Tom, CPA · Updated October 27, 2026

Part of: Rental Property Taxes

TL;DR: Net rental income is net investment income by default. The 3.8% NIIT applies to the smaller of your net investment income or your modified AGI above $200,000 single or $250,000 married filing jointly. These thresholds are not indexed. Rental income escapes NIIT if it comes from a non-passive trade or business, most often for real estate professionals who meet the 500-hour safe harbor. Gains on selling a rental are usually NII too.

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.

Your tenant pays the mortgage; the IRS pays for the roof (eventually, over 27.5 years). The IRS also takes 3.8% of the rent profit once your income is high enough. The net investment income tax under section 1411 was added in 2013 and quietly reaches more landlords every year because its thresholds are frozen.

Main sources: the IRS NIIT questions and answers, the Form 8960 instructions and Reg. 1.1411-4.

CPA Warning Label: The NIIT thresholds have not moved since 2013. Every year more landlords cross them without getting richer.

Rental income is NII by default

Section 1411(c)(1)(A)(i) lists rents as net investment income, unless they are derived in the ordinary course of a trade or business that is not a passive activity (and not a trading business). For most landlords, the rental is passive (or not a trade or business at all), so net rents are NII.

Net is the key word. NII is rental income minus properly allocable deductions: mortgage interest, property taxes, depreciation, repairs and other Schedule E expenses. If the rental shows a tax loss, there is no rental NII. Suspended passive losses that are released can reduce NII in the year they are allowed.

Other rules:

• Self-rental: rent from property you lease to a business in which you materially participate is generally recharacterized as nonpassive and excluded from NII under Reg. 1.1411-4(g)(6). See self-rental rules.
• Short-term rentals with average stays of seven days or less where you materially participate may be a nonpassive trade or business; the income may then be outside NII. Whether an STR is a trade or business depends on the facts.
• K-1 rental income from syndications is generally NII for passive investors. See syndication K-1 taxes.

REPS trade-or-business exception

Rental income is not NII if it is from a trade or business that is nonpassive to you. Real estate professionals (REPS) who materially participate in their rentals have a path out.

The 500-hour safe harbor

Reg. 1.1411-4(g)(7) provides a safe harbor: a real estate professional who participates in rental real estate activities for more than 500 hours during the year, or has done so in any five of the preceding ten tax years, is treated as engaged in a trade or business for those activities. The gross rental income and gains are then not NII.

• The safe harbor requires that you meet REPS for the year: more than half of your personal services and more than 750 hours in real property trades or businesses in which you materially participate.
• The 500 hours are in rental real estate activities (generally, the aggregated group if you elected to aggregate).
• If you do not meet the safe harbor, you can still argue that the rentals are a trade or business and that you materially participate; it is a facts-and-circumstances question.

See real estate professional status.

Not a REPS but active?

An active participant using the $25,000 allowance is still passive under section 469, so rental income stays NII. Managing your own fourplex on weekends does not, by itself, escape NIIT.

Thresholds

NIIT is 3.8% of the smaller of net investment income or the excess of modified adjusted gross income over:

These are set in the statute and not indexed for inflation, per the IRS. Estates and trusts face NIIT at a much lower threshold: the start of the top trust bracket, which is indexed. A rental held in a non-grantor trust can trigger NIIT at low income.

MAGI is AGI plus certain excluded foreign earned income; see foreign earned income. Pretax 401(k) contributions and other above-the-line items reduce MAGI and can reduce NIIT. NIIT is reported on Form 8960 and is included in the tax used for estimated tax safe harbors; see landlord estimated taxes.

Sale gains

Gain on the sale of rental property is NII under section 1411(c)(1)(A)(iii), unless the property was held in a nonpassive trade or business. That includes:

• capital gain on appreciation;
• unrecaptured section 1250 gain (depreciation);
• section 1231 gain.

Excluded or deferred gain is not NII. Gain deferred in a 1031 exchange is not NII until recognized; gain excluded under section 121 on a former home is not NII. For an installment sale, NII is recognized as payments are received.

Real estate professionals using the 500-hour safe harbor: gain on the sale of property used in the trade or business is generally not NII. Suspended passive losses released on sale reduce NII.

State tax: some states without an income tax have no added tax, but NIIT is federal and applies everywhere; see no-income-tax states.

Example

Illustration: Larry and Fran are married filing jointly. 2026 wages $230,000. Net rental income after depreciation $35,000. Interest and dividends $5,000. MAGI: $270,000. Neither qualifies as a real estate professional.

• Net investment income: $35,000 + $5,000 = $40,000.
• MAGI over threshold: $270,000 minus $250,000 = $20,000.
• NIIT: 3.8% of the smaller ($20,000) = $760.

The sale year. In 2027 they sell a rental with a $300,000 gain ($90,000 unrecaptured section 1250 and $210,000 long-term capital gain). Assume the same other income. MAGI: $570,000. NII: $340,000. Excess MAGI: $320,000. NIIT: 3.8% of $320,000 = $12,160, on top of income tax.

If Fran were a real estate professional with more than 500 hours in the rentals: the $35,000 rental income and the sale gain would be excluded from NII. NII would be $5,000 of interest and dividends, and NIIT would be 3.8% of $5,000 = $190 in 2026.

Ways landlords reduce NIIT legitimately:

• maximize pretax retirement contributions to reduce MAGI;
• use depreciation, including cost segregation, to reduce net rental income;
• spread a sale with an installment sale, or defer it with a 1031 exchange;
• qualify for REPS only if the hours are genuine; the IRS audits REPS claims frequently.

Allocating deductions

Form 8960 lets you subtract properly allocable deductions from gross NII. For rentals, that is mainly the Schedule E expenses already netted. Other deductions can also reduce NII:

• investment interest expense (to the extent deducted);
• state and local income tax allocable to NII, using a reasonable method, subject to the itemized deduction limits;
• investment expenses allowed as deductions.

Suspended losses matter. If a rental produced passive losses in earlier years that are released in the sale year, they reduce NII in that year. If passive losses from one rental are allowed against passive income from another, the net is what counts.

Grouping and the regrouping election

Because the NIIT applies the section 469 rules, how you group activities matters. The NIIT regulations gave taxpayers a fresh-start opportunity to regroup activities in the first year they were subject to NIIT. Grouping rentals with each other, or a self-rental with the operating business, can change whether income is NII. Regrouping rules are technical; get advice before you change your groupings.

Common mistakes

• Assuming a rental loss eliminates NIIT. Rental losses reduce NII, but interest, dividends and capital gains can still produce NIIT.
• Forgetting the sale year. Even landlords far below the thresholds can cross them in the year of a sale, and the entire gain can become NII.
• Claiming the REPS exception without the hours log. The 500-hour safe harbor still requires REPS status, which requires contemporaneous evidence of hours.
• Ignoring trusts. A rental held in a non-grantor trust that retains income can owe NIIT at a fraction of the individual thresholds. Distributing income to beneficiaries can shift it to their lower thresholds.
• Confusing NIIT with self-employment tax. Rental income is generally not subject to self-employment tax, and NIIT is separate. Short-term rentals with substantial services can face self-employment tax instead.