How to Avoid Net Investment Income Tax: Bonds, CRTs, and Installments

To avoid the Net Investment Income Tax, you need to move one of two numbers: your modified adjusted gross income (MAGI) or your net investment income. The tax is 3.8% of whichever is smaller, so pulling either figure down shrinks or eliminates what you owe.¹ The MAGI thresholds are $250,000 for married couples filing jointly, $200,000 for single filers and heads of household, and $125,000 for married filing separately. They have not been indexed for inflation since the tax took effect in 2013, which is why more households drift into range every year.²

The “lesser of” rule is where planning lives. A single filer with $230,000 MAGI and $50,000 of net investment income pays the 3.8% on $30,000, not $50,000, because only $30,000 sits above the $200,000 threshold. Drop the MAGI to $200,000 and the tax disappears entirely, even though the investment income never changed.

Net investment income covers interest, dividends, annuities, royalties, rents, capital gains, and income from passive business activities. It does not include wages, Social Security, self-employment income, tax-exempt interest, or distributions from 401(k)s and IRAs.³ Those exclusions are the map. Every strategy below either pushes income into a category the tax doesn’t reach, or defers it so it never stacks up above the threshold in a single year.

One boundary before the strategies: if you live abroad and claim the foreign earned income exclusion, the excluded income gets added back to your AGI when you compute MAGI for the NIIT. A below-the-line AGI does not mean you are safe.¹

Max Out Tax-Deferred Retirement and HSA Contributions

Traditional 401(k), 403(b), and traditional IRA contributions reduce AGI dollar for dollar, which directly lowers MAGI. If your income sits just above the threshold, this alone can eliminate the tax.

For 2026, the 401(k) and 403(b) elective deferral limit is $24,500. Workers 50 and older can add an $8,000 catch-up for a total of $32,500. Under SECURE 2.0, workers aged 60 through 63 get an enhanced catch-up of $11,250, bringing them to $35,750.⁴ Traditional IRA contributions max at $7,500, with a $1,100 catch-up at 50 and older.⁵

Health Savings Accounts do the same job. HSA contributions are above-the-line deductions, and the 2026 limits are $4,400 for self-only coverage and $8,750 for family coverage under a high-deductible health plan.⁶ Qualified HSA distributions are never taxed, which makes the account a clean MAGI reducer with no back-end cost.

There is a second-order benefit worth knowing. When you eventually take distributions from a qualified plan or IRA, those distributions do not count as net investment income.² They add to MAGI, so they can still push you over the threshold, but they don’t feed the NII side of the calculation. A retiree living mostly on plan distributions can have a high MAGI and still owe little NIIT if outside investment income stays modest.

Shift Into Tax-Exempt Municipal Bonds

Interest on state and local municipal bonds is explicitly excluded from net investment income.² Muni interest also stays out of MAGI for regular tax purposes, so it works on both sides of the NIIT formula at once. That dual effect is why munis show up in almost every conversation about reducing this tax.

The comparison against taxable bonds widens once you factor in the 3.8%. A corporate bond at 5% loses to both regular income tax and the surcharge; a muni at a lower stated yield can win on an after-tax basis for anyone clearly above the threshold.

Watch one trap. Capital gains on muni bonds and muni bond funds are not excluded. If you sell a discount bond at a premium, or trade fund shares at a gain, that gain is net investment income. The exclusion protects coupon payments, not appreciation.

Materially Participate in Your Business

Income from a business you do not materially participate in is passive, and passive business income is net investment income.³ Cross into material participation, and the same income from the same business is nonpassive and falls outside the NIIT entirely. For owners of profitable S-corporations, partnerships, and LLCs, this is often the single largest reduction available.

Material participation runs through the seven tests in Treasury Regulation 1.469-5. You only need to pass one. The most common is the 500-hour test: more than 500 hours in the activity during the year, and you qualify.⁷ Other tests turn on being the only substantial participant, or having materially participated in any five of the preceding ten years. Section 469 requires involvement that is regular, continuous, and substantial.⁸

Documentation decides these fights. Keep a contemporaneous log with dates, activities, and hours. Calendar entries and email records help, but a dedicated time log is what wins on audit.

The Self-Employment Tax Trade-Off

For partnership and sole proprietorship income, material participation removes the 3.8% NIIT but can expose the income to self-employment tax at 15.3% up to the Social Security wage base and 2.9% above it, plus the 0.9% Additional Medicare Tax at higher thresholds.² Trading one tax for a bigger one is not a win. Run the full comparison before making the switch.

S-corporation owners have it easier. Distributions to a materially participating shareholder are neither self-employment income nor net investment income. Only the reasonable salary the corporation pays you carries payroll tax. That is close to a pure win, which is a large part of why S-corps are popular with high-income owners.

The Real Estate Professional Exception

Rental income is generally passive no matter how many hours you put in, so it usually counts as net investment income. The exception is the real estate professional rule: more than 750 hours during the year in real property businesses in which you materially participate, and that time must exceed half of all personal services you perform across all activities.⁹ Qualify, and your rental activities can be reclassified as nonpassive, pulling that rental income out of the NIIT.

The majority-of-time requirement means real estate has to be your main occupation. A physician with three rentals on the side will not qualify. A full-time property manager, developer, or real estate agent who also owns rentals often can.

Spread Large Gains With Installment Sales

A big one-time gain can push MAGI far above the threshold and trigger the NIIT on the gain itself along with other investment income that would otherwise have stayed below the line. Section 453 lets you spread the gain by taking payments across multiple years, and gain is recognized proportionally as payments arrive.¹⁰

Take a rental property with a $500,000 gain. Recognized all at once, it might push a married couple’s MAGI past $700,000 and expose $450,000 to the 3.8%, roughly $17,100 in NIIT. Spread over five years at $100,000 per year, the couple may stay close enough to the $250,000 threshold that only a small slice triggers the tax in any given year, and possibly none if other income is low.

The interest the buyer pays on the installment note is itself net investment income each year.¹¹ Build that into the schedule when you structure the deal. Also note that installment sales are not available for publicly traded securities or for inventory sales by dealers. The method works best for real estate and closely held business interests.

Use a Charitable Remainder Trust for One Big Appreciated Asset

A Charitable Remainder Trust (CRT) lets you transfer a highly appreciated asset into a tax-exempt trust, have the trust sell it without immediate gain recognition, and receive an income stream for a term of years or for life. The gain is recognized gradually as the trust pays you out, which flattens the MAGI spike much like an installment sale. You also get a charitable income tax deduction in the year you fund the trust, which further trims MAGI that year.

The rules are strict. The trust must distribute at least 5% and no more than 50% of its initial value annually, and the present value of the charitable remainder must be at least 10% of the contributed assets. Miss any of those, and the trust loses its tax-exempt status. Setting one up requires an attorney familiar with the payout calculations and IRS filings, and fees are typically several thousand dollars or more.

CRTs make sense when you hold a single concentrated appreciated position (a business interest, a large block of stock) and want to diversify without a one-year tax event. For smaller or less appreciated assets, the complexity usually is not worth it.

Use the Home Sale Exclusion in Full

Section 121 excludes up to $250,000 of gain on a primary residence for single filers, and $500,000 for married couples filing jointly, if you owned and lived in the home for at least two of the five years before the sale. The excluded portion also stays out of net investment income.²

A married couple with $600,000 of gain recognizes only $100,000 after the exclusion, and only that $100,000 enters the NII calculation. If their MAGI exceeds $250,000 by $50,000, the 3.8% applies to $50,000, not the full sale. If your gain will run past the exclusion, an installment structure on the excess can spread the remainder across years.

Deductions and Filing on Form 8960

The NIIT is reported on Form 8960, attached to your individual return. The form runs the “lesser of” calculation and applies the 3.8%.¹² You can reduce the net investment income figure on the form by claiming deductions properly allocable to that income, including investment interest expense and state and local income taxes attributable to investment income.¹¹ Advisory fees, margin interest, and state taxes on investment gains commonly get missed. Make sure they land on the form.

The NIIT is subject to estimated tax rules. If you expect investment income to spike from a property sale, a large distribution, or a strong market year, adjust your quarterly estimates for the quarter the income hits. Failing to account for the tax in your estimates can trigger an underpayment penalty at filing.²

1
Internal Revenue Service. Topic No. 559, Net Investment Income Tax
2
Internal Revenue Service. Questions and Answers on the Net Investment Income Tax
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Office of the Law Revision Counsel. 26 USC 1411 – Imposition of Tax
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Internal Revenue Service. 401(k) Limit Increases to $24,500 for 2026; IRA Limit Increases to $7,500
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Internal Revenue Service. Retirement Topics – IRA Contribution Limits
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Internal Revenue Service. Revenue Procedure 2025-19 – 2026 Inflation Adjusted Items
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eCFR. 26 CFR 1.469-5 – Material Participation
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Office of the Law Revision Counsel. 26 USC 469 – Passive Activity Losses and Credits Limited
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Internal Revenue Service. Publication 925 – Passive Activity and At-Risk Rules
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Office of the Law Revision Counsel. 26 USC 453 – Installment Method
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Internal Revenue Service. Instructions for Form 8960 – Net Investment Income Tax
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Internal Revenue Service. About Form 8960, Net Investment Income Tax – Individuals, Estates, and Trusts