The Net Investment Income Tax of 3.8% (IRC 1411) applies to unearned income – i.e. income from interest, dividends, annuities, royalties, rents (not derived from the ordinary course of trade or business). The tax, however, does not apply to interest from tax-exempt bonds, veteran’s benefits.
This new tax does applies to sale of homes if your adjusted gross income (AGI) is above $200k (unmarried) or $250k (married) and you have capital gains above the $250/$500k exclusion for a “qualifying residence.”
For Real Estate Rental Property
To avoid the 3.8% tax on real estate rental income or gains from the sale of property, you must meet 2 requirements:
- The income/gain must be derived from a “trade or business” and
- The taxpayer cannot be “passive” but must be materially participating in managing the property. This requires meeting various tests, including the Real Estate Professional Exception (i.e. more than 50% of your trade or businesses is in real estate and you can show you put in a minimum of 750 hours/yr.)
Whether your activity qualifies as a “trade or business” and whether you are deemed to be “materially participating” in the activity requires a detailed analysis and review of the transaction and the individual’s involvement in the business.
If you have questions on the above information concerning the Net Investment Income Tax, or you are facing an audit before the IRS or California Franchise Tax Board, contact our San Diego tax law attorney.