Since the inauguration, it appeared that the Net Investment Income Tax (NIIT), otherwise known as the 3.8% Medicare Surtax, which passed as part of the Affordable Care Act, was going to disappear. However, with the gridlock in Congress and the failure to repeal and replace Obamacare, it now seems that the NIIT is here to stay, at least for now.
Given the failure to repeal and replace, it is still relevant to consider passive activity rules in connection with the NIIT. The NIIT generally applies to income derived from a passive activity. Under the passive activity rules, rental real estate is generally considered a passive activity unless the taxpayer can establish on an annual basis that he or she is a (1) real estate professional and (2) materially participates in rental real estate activities pursuant to IRC Section 469. When both qualifications are met, the rental income is considered non-passive and exempt from NIIT.
Similarly, the 3.8% NIIT will generally apply on the capital gain from the sale of rental real estate unless the gain is derived from a non-passive trade or business. Therefore, it is still necessary to reference the passive activity rules to determine whether the capital gain is exempt from NIIT. If the property is owned at the partnership level, the passive activity rules are applied at the partner-individual level. Before selling, consult with your tax attorney to evaluate your tax exposure and to determine whether an effective strategy may mitigate your taxes.
The opinions expressed here are based on the laws as of the date written. The laws are subject to change, and if they do, the statements expressed will be subject to change.
DISCLAIMER: To ensure compliance with requirements imposed by the U.S. Treasury Regulations, we inform you that any tax advice contained in this blog is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.