You reduce the net investment income tax by lowering one of two numbers: your modified adjusted gross income (MAGI), or your net investment income. The 3.8% applies only to the smaller of those two amounts, where the first is measured as how far your MAGI exceeds your filing-status threshold. A strategy that shrinks the larger number does nothing for this tax.
This guide assumes you know the basics. If you want the thresholds, what counts as investment income, and how Form 8960 works, start with Nino’s explainer on the net investment income tax.
How can you reduce net investment income tax?
Start by finding out which number is smaller for you, because that is the one worth working on.
Take a single filer with $260,000 of MAGI and $30,000 of net investment income. Their MAGI is $60,000 over the $200,000 threshold, so the tax applies to the smaller figure, $30,000, for $1,140 of NIIT. Lowering MAGI by $20,000 changes nothing here. Cutting investment income does.
Now take a single filer with $215,000 of MAGI and $40,000 of investment income. The excess over the threshold is $15,000, so the tax is $570. If they can still defer another $15,000 of salary into a pre-tax 401(k), their MAGI falls to the threshold and the tax disappears, even though their investment income has not moved.
The IRS notes that the thresholds ($200,000 single or head of household, $250,000 married filing jointly, $125,000 married filing separately) “are not indexed for inflation,” so more households cross them each year as wages and portfolios grow. If your MAGI is close to the line, small changes can matter. Nino’s guide to what MAGI is covers how the NIIT definition differs from the others.
Municipal bonds are the rare move that works on both sides. Tax-exempt interest stays out of AGI and out of net investment income, so shifting taxable interest into munis can lower both numbers at once, as long as the after-tax yield still makes sense for you.
Do retirement contributions reduce NIIT?
Yes, but only on the MAGI side. Pre-tax retirement account contributions and HSA contributions reduce your AGI, which lowers MAGI. They do not reduce dividends, interest, or capital gains, so they only cut NIIT when the MAGI excess is the smaller of your two numbers, as in the second example above.
Distributions work the other way around. The IRS lists distributions from qualified plans, including 401(k)s, 403(b)s, and traditional and Roth IRAs, as income that is not net investment income. Taxable distributions still raise your MAGI, though, which can push more of your investment income under the tax. A Roth conversion has the same effect, and Nino’s guide on whether Roth conversions count as income covers how that plays out.
If you are 70½ or older and give to charity, a qualified charitable distribution from your IRA is worth a look. Under IRS Publication 590-B, a QCD goes directly to the charity and is excluded from your income, so it can satisfy a required distribution without adding to MAGI.
Can capital losses reduce net investment income tax?
They can. Tax-loss harvesting offsets gains inside net investment income, and the Section 1411 regulations also allow net capital losses up to the $3,000 limit that applies for regular tax. Losses beyond that carry forward, and they keep their value for NIIT in later years. Nino’s guide to tax-loss harvesting walks through the mechanics, and the tax-loss harvesting calculator shows the federal and state tax saved, including the 3.8% NIIT.
Watch the wash-sale rule. If you buy substantially identical securities within 30 days before or after the sale, the loss is disallowed for now, which means it does not help with NIIT that year either. IRS Publication 550 explains how the rule works.
You can also keep gains from landing in the first place:
- Giving shares you have held for more than a year means the gain is never realized. The charitable deduction itself is not one of the deductions allowed against net investment income, so the benefit comes from the avoided sale.
- Spreading sales across tax years can keep one year from carrying all the gain.
- Gain excluded under the $250,000 / $500,000 primary residence exclusion is also excluded from NIIT, according to the IRS.
What deductions lower net investment income?
Only deductions that are properly allocable to investment income count. The IRS names investment interest expense, investment advisory and brokerage fees, expenses related to rental and royalty income, tax preparation fees, and state and local income taxes allocable to that income. If you borrow on margin or take an investment loan to buy taxable securities, the interest can reduce net investment income as well as your regular tax.
These deductions come with limits. Investment interest is generally capped at your net investment income for the year, and the items depend on itemizing and on the regular-tax limits that apply to them. The Form 8960 instructions include a worksheet that applies those limits, which can shrink the amount you actually subtract.
Does depreciation reduce investment income for NIIT?
For rental property, it does. Rental income usually counts as net investment income, and depreciation lowers the net rental income that gets counted. The catch comes later: when you sell the property, the gain reflects the depreciation you took, and that gain is generally investment income too.
Whether business or rental income is in the NIIT base depends largely on the passive activity rules. A passive activity is a business you do not materially participate in, and income from it is net investment income. Material participation can be met in several ways, the most common being more than 500 hours of work in the activity during the year, under Treasury Regulation 1.469-5T. Meet it, and that business income generally stays out of NIIT.
Rental real estate has its own path. Under a safe harbor in the NIIT regulations, real estate professionals who spend more than 500 hours a year in rental real estate, or who did so in five of the prior ten years, can treat rental income and gains from that activity as business income outside NIIT. Hours need records, so log them as you go.
How does NIIT apply to the sale of a business?
It depends on what you sell and how involved you were. Gain on property used in a business you materially participate in is generally outside net investment income. If you sell a partnership interest or S corporation stock, the Form 8960 instructions require an adjustment so only the portion tied to passive activity is taxed. Gain on C corporation stock you hold as an investment is generally net investment income.
Two tools can change the outcome. An installment sale spreads the gain over the years you receive payments, which may keep more of it under the threshold, although the interest on the note is investment income. And if your shares qualify under Section 1202, gain excluded as qualified small business stock is excluded from gross income, so NIIT does not apply to it.
A sale year raises plenty of other questions. Nino’s tax and cash checklist for a liquidity event covers the rest.
How Nino helps you plan around NIIT
Most NIIT planning has to happen before December 31, while you can still move a sale, harvest a loss, or add a contribution. Nino pairs AI-powered planning software with a dedicated CFP and CPA who project both numbers for your year, show which one is smaller, and help you time sales, harvesting, and contributions around them.
Book a free consultation to see where your MAGI and investment income land this year. Every Advisor plan includes a 30-day money-back guarantee; see plans and pricing.