What Is Net Investment Income and How Is It Taxed?

The net investment income tax is a 3.8% federal surtax on investment earnings owed by higher-income taxpayers. It applies when your modified adjusted gross income (MAGI) crosses $200,000 for single filers or $250,000 for married couples filing jointly, and it hits the smaller of two numbers: your net investment income for the year, or the amount your MAGI exceeds the threshold. Net investment income itself is what’s left after you subtract allowable expenses from interest, dividends, capital gains, rental and royalty income, and certain passive business income.¹ The thresholds have never been indexed for inflation, so more taxpayers cross them every year.

What Counts as Investment Income

Section 1411 of the Internal Revenue Code lists the categories that flow into net investment income. Interest from savings accounts and bonds, dividends from stocks and mutual funds, capital gains from selling investments or real estate, rental and royalty income, and payments from non-qualified annuities all count.¹ Gains from selling an interest in a partnership or S corporation are also included when you were a passive owner.

Income from a business you don’t actively run gets the same treatment. A silent partnership stake or a managed fund investment is a “passive activity” under the tax code, and its profits become part of net investment income.² If you materially participate in the business, that same income generally stays outside the NIIT.

What Doesn’t Count

Wages, salaries, and tips are not investment income. Self-employment earnings already subject to self-employment tax are excluded too. So are Social Security benefits, unemployment compensation, and alimony.³ Tax-exempt interest, including income from municipal bonds, sits outside both net investment income and MAGI.

Distributions from qualified retirement plans, including 401(k), 403(b), 457(b), traditional IRA, and Roth IRA accounts, are not net investment income.⁴ There’s a catch, though. Those distributions still raise your overall adjusted gross income, and a higher AGI can lift your MAGI above the threshold. So a large traditional IRA withdrawal isn’t taxed by the NIIT itself, but it can trigger the NIIT on your dividends and capital gains by pushing your MAGI over the line. Retirees drawing down accounts often miss this interaction.

Deductions That Reduce the Amount

The “net” part matters. You subtract allowable expenses before applying the 3.8% rate, but the list of what’s allowable narrowed after the Tax Cuts and Jobs Act, and the One Big Beautiful Bill Act made those cuts permanent. Investment advisory fees, custodial fees, and tax preparation fees tied to investment income are no longer deductible for any purpose, including on Form 8960.³

What still reduces net investment income:

Investment interest expense, such as interest on margin loans used to buy taxable investments.
State, local, and foreign income and real property taxes attributable to your net investment income.
Rental and royalty expenses reported through Schedule E, including property management costs, maintenance, depreciation, and insurance.

The governing rule is that an expense must be allowable in computing your regular taxable income before it can reduce net investment income.¹ Expenses that serve both personal and investment purposes only count in the investment-related portion.

The Thresholds and How the 3.8% Is Calculated

The MAGI thresholds are set by statute and are not adjusted for inflation:

Married filing jointly or qualifying surviving spouse: $250,000
Single or head of household: $200,000
Married filing separately: $125,000

For most people, MAGI equals AGI from Form 1040. Taxpayers who claim the foreign earned income exclusion under Section 911 must add that excluded income back, and those with income from controlled foreign corporations or passive foreign investment companies may face further adjustments.¹

Once your MAGI is over the threshold, the tax is 3.8% of the smaller of two figures: your net investment income, or the amount by which MAGI exceeds the threshold.³

Two examples show why that comparison matters. A single filer with MAGI of $210,000 and net investment income of $30,000 has a MAGI excess of $10,000. Because $10,000 is less than $30,000, the tax applies to $10,000, and the bill is $380. Now take a single filer with MAGI of $275,000 but only $5,000 of net investment income. The MAGI excess is $75,000, but investment income is $5,000, so the tax applies to the smaller figure and costs $190. The tax can never exceed 3.8% of your net investment income, no matter how far your MAGI runs past the threshold.

Selling Your Home

Selling a primary residence usually doesn’t trigger the NIIT. Any gain you exclude under the standard home-sale exclusion, up to $250,000 for a single filer or $500,000 for a married couple filing jointly, is also excluded from net investment income.⁵ Only the gain above that exclusion counts.

Take a married couple with a $600,000 gain on their home. After applying the $500,000 exclusion, $100,000 of recognized gain remains, and that $100,000 enters the NIIT calculation.¹ A second home or vacation property gets no exclusion, and the full gain on investment real estate is included.

Material Participation and Business Income

Whether business or rental income lands inside or outside the NIIT often turns on material participation. The IRS provides seven tests, and you only need to satisfy one. The most common is putting in more than 500 hours of work in the activity during the tax year.⁶ Other tests cover situations where you did substantially all the work, worked more than 100 hours and at least as much as anyone else, participated across several activities totaling more than 500 hours, or materially participated in earlier years under specific patterns.

This distinction can be significant for landlords and small-business owners. Someone who actively manages rental properties for well over 500 hours a year may be able to keep that rental income outside the NIIT. A hands-off investor in the same property cannot.

Trusts and Estates Face a Much Lower Threshold

Trusts and estates owe the same 3.8% rate, but the threshold is far lower. The tax applies once AGI exceeds the dollar amount where the highest trust tax bracket begins, roughly $16,000 for 2026.³ Unlike the individual thresholds, this figure is adjusted annually for inflation.

The tax hits the lesser of the trust’s undistributed net investment income or its AGI above the threshold. Distributions to beneficiaries reduce the trust’s own exposure because the income shifts to the beneficiary’s return, where the individual thresholds apply. For families holding investments in trust, distribution timing can meaningfully change the total NIIT paid across the trust and its beneficiaries.

Filing and Estimated Tax Payments

You report and calculate the tax on Form 8960 and attach it to your individual return whenever your MAGI exceeds the applicable threshold and you have any net investment income.³ The form works through each category of investment income, subtracts your allowable deductions, and applies the 3.8% rate to the lesser of net investment income or MAGI excess.

The NIIT is subject to the estimated tax rules. Employers don’t withhold for it, so if you expect to owe, factor it into your quarterly estimated payments or increase your wage withholding to cover the liability.¹ Taxpayers with a large capital gain event or a mid-year rental property sale are especially exposed to underpayment penalties if they wait until April to think about it.

1
Internal Revenue Service. Questions and Answers on the Net Investment Income Tax
2
GovInfo. 26 USC Chapter 2A – Unearned Income Medicare Contribution
3
Internal Revenue Service. 2025 Instructions for Form 8960 – Net Investment Income Tax
4
Internal Revenue Service. Instructions for Form 8960 (2025)
5
Internal Revenue Service. Net Investment Income Tax
6
Internal Revenue Service. Publication 925, Passive Activity and At-Risk Rules