Most investors price a property sale at the long-term capital-gains rate and stop there. But for higher earners a second federal layer — the 3.8% net investment income tax — sits quietly on top, turning a 20% rate into 23.8% and reaching rental income and REIT dividends as well. Because its income thresholds have been frozen since 2013, it pulls in more investors every year. This memo explains exactly how it works in 2026 and the levers that reduce it.
- The NIIT is a flat 3.8% on net investment income, applied above frozen MAGI thresholds of $200,000 (single) and $250,000 (married filing jointly).
- It is charged on the lesser of your net investment income or the amount your MAGI exceeds the threshold — so it is partly a function of total income, not just investment income.
- Real estate capital gains, depreciation recapture, most rental income, royalties, and REIT dividends are all potentially subject to it.
- Deferring the gain (1031, DST, Opportunity Zone), spreading it (installment sale), or qualifying as a materially-participating real estate professional can each cut or eliminate it.
What the NIIT is
Enacted in 2013 to help fund the Affordable Care Act, the net investment income tax (NIIT) — sometimes called the Medicare surtax — is a flat 3.8% imposed under Section 1411 on the investment income of higher-income taxpayers. It is separate from, and stacks on top of, the regular income tax and capital-gains tax. It is reported on Form 8960 and flows onto your Form 1040.
Crucially, it is not a simple 3.8% of all investment income. You owe 3.8% on the lesser of (a) your net investment income for the year, or (b) the amount by which your modified adjusted gross income exceeds the applicable threshold. That two-part test means a large one-time gain can push you well past the threshold and expose most of the gain to the surtax.
Who owes it — the frozen thresholds
The MAGI thresholds that trigger the NIIT are set by statute and, unusually, are not indexed for inflation. They are the same in 2026 as in 2013:
- $250,000 — married filing jointly (and qualifying surviving spouse)
- $200,000 — single and head of household
- $125,000 — married filing separately
Because they never rise, ordinary inflation and rising incomes steadily pull more taxpayers into the tax — a slow form of bracket creep. For a real estate investor, even a single profitable sale can lift MAGI above the threshold for that year, making the NIIT a near-certainty on a large gain.
How it hits real estate
Several common forms of real estate income fall within net investment income:
- Capital gains on the sale of investment property — including the depreciation-recapture portion taxed at up to 25%.
- Rental income, net of expenses, when the activity is passive to you.
- Royalty income from mineral and similar interests.
- REIT dividends and most fund distributions, including dividends from private and non-traded REITs.
Gain excluded under the Section 121 primary-residence exclusion is not subject to the NIIT, because excluded gain never enters income. Wages and self-employment income are also outside the NIIT (they face the additional Medicare tax instead) — a distinction that matters for the real estate professional rules below.
The real estate professional exception
Rental income is generally passive, and passive income is squarely within the NIIT. But there is an important carve-out: if you qualify as a real estate professional under Section 469 and materially participate in your rental activities, that rental income is treated as non-passive — and non-passive income derived in the ordinary course of a trade or business is excluded from net investment income.
The IRS provides a safe harbor: a real estate professional who participates in rental real estate for more than 500 hours in the year (or 500 hours in five of the last ten years) is presumed to be in a non-passive trade or business for NIIT purposes. The rules are technical and documentation-heavy, so this is a strategy to run with your CPA — but for active operators it can remove the 3.8% from rental income entirely.
How investors reduce it
Because the NIIT depends on both investment income and total MAGI, there are levers on both sides:
- Defer the gain. A 1031 exchange or a DST defers the entire gain — and with it the NIIT — into the replacement property. An Opportunity Zone investment does the same and can erase tax on future appreciation.
- Spread the gain. An installment sale recognizes gain over several years, which can keep MAGI lower in each year and reduce how much of the gain crosses the threshold.
- Become non-passive. Qualifying as a materially-participating real estate professional can move rental income out of net investment income.
- Lower MAGI. Retirement-plan contributions, charitable giving, and harvesting capital losses all reduce the MAGI side of the calculation.
You can estimate the NIIT layer on a specific sale with our capital gains tax calculator, which separates it from the underlying capital-gains and recapture tax.
Frequently Asked Questions
Is the 3.8% NIIT on top of capital gains tax?
Yes. It is a separate surtax that stacks on the regular capital-gains tax, so a top-bracket investor effectively pays 23.8% federally on a long-term gain (20% + 3.8%) before state tax.
Are the NIIT thresholds adjusted for inflation?
No. The $200,000 single and $250,000 joint thresholds have been frozen since the tax began in 2013, so more taxpayers are pulled in over time even without real income growth.
Does a 1031 exchange avoid the NIIT?
Effectively yes for the deferred gain — because a properly structured 1031 exchange defers recognition of the gain, there is no investment income to tax now. The NIIT would only apply later if and when you recognize the gain.
Is rental income subject to the NIIT?
Usually, if it is passive to you. But if you qualify as a real estate professional and materially participate, the rental income can be treated as non-passive and excluded from net investment income.
Is depreciation recapture subject to the 3.8%?
Yes. The recaptured portion of a gain is still investment income, so it can be hit by the NIIT in addition to the up-to-25% recapture rate.
Glossary
- Net Investment Income Tax (NIIT)
- A 3.8% surtax under Section 1411 on the lesser of net investment income or MAGI above $200k single / $250k joint.
- Modified Adjusted Gross Income (MAGI)
- Adjusted gross income with certain items added back; the figure compared against the NIIT thresholds.
- Real Estate Professional
- A taxpayer who meets the Section 469 hours tests, allowing rental activity to be treated as non-passive.
- Form 8960
- The IRS form on which the net investment income tax is computed and reported.
Disclosures
This memo is published by Baker 1031 for general informational and educational purposes only. It is not investment, legal, or tax advice, and is not an offer to sell or a solicitation to buy any security. Tax rules, rates, and thresholds are complex, depend on your individual circumstances, and change over time; consult your own CPA and attorney before acting.
Securities offered through Aurora Securities, Inc., member FINRA / SIPC; Baker 1031 Investments is independent of Aurora Securities, Inc. Private placements referenced are sold only to verified accredited investors and involve substantial risk including loss of principal.
