What Capital Gains Are Excluded From Net Investment Income Tax?

Capital gains, which are profits from selling an asset, are a key part of investment earnings. Understanding how these gains interact with the Net Investment Income Tax (NIIT) is important for many taxpayers. This article clarifies which capital gains are not subject to the NIIT, helping individuals navigate their tax obligations.

Overview of the Net Investment Income Tax

The Net Investment Income Tax (NIIT) is a 3.8% tax applied to certain net investment income. Enacted as part of the Health Care and Education Reconciliation Act of 2010, this tax became effective on January 1, 2013. Its purpose is to help fund healthcare reform by broadening the tax base to include investment earnings for higher-income individuals, estates, and trusts.

Individuals are subject to the NIIT if their modified adjusted gross income (MAGI) exceeds specific thresholds. For those filing as single or head of household, the threshold is $200,000. Married individuals filing jointly or qualifying widow(er)s face a threshold of $250,000, while married individuals filing separately have a threshold of $125,000. For estates and trusts, the NIIT applies if their adjusted gross income (AGI) exceeds the highest tax bracket threshold, which was $15,200 in 2024 and $15,650 in 2025.

Net investment income generally includes a variety of earnings from investments. This encompasses interest, dividends, and capital gains. It also includes income from rental and royalty activities, as well as non-qualified annuities. Furthermore, income derived from a trade or business that is considered a passive activity to the taxpayer, or from trading in financial instruments or commodities, typically falls under net investment income. The tax is levied on the lesser of the net investment income or the amount by which the MAGI exceeds the applicable threshold.

Capital Gains Categories Excluded from NIIT

Certain types of capital gains are not subject to the Net Investment Income Tax, primarily due to their nature or specific provisions within the tax code. These exclusions are important for taxpayers to understand when calculating their potential NIIT liability. The distinctions often depend on how the property was used or classified.

Gains from the Sale of a Personal Residence

A key exclusion from NIIT involves capital gains from the sale of a personal residence. Under Internal Revenue Code Section 121, taxpayers can exclude a certain amount of gain from the sale of their main home from their gross income for regular income tax purposes. This exclusion also extends to the NIIT, meaning any gain excluded for regular income tax is also excluded from the NIIT calculation.

The exclusion amount is up to $250,000 for single filers and up to $500,000 for married couples filing jointly. To qualify, the taxpayer must have owned and used the home as their principal residence for at least two of the five years leading up to the sale. If the gain exceeds these exclusion limits, the excess may be subject to the NIIT if the taxpayer’s modified adjusted gross income surpasses the applicable thresholds.

Gains from Property Used in an Active Trade or Business

Capital gains arising from the disposition of property used in an active trade or business are generally not considered net investment income for NIIT purposes. The distinction between “active” and “passive” business activities is important in determining whether such gains are excluded. If a taxpayer materially participates in a trade or business, the income, including gains from the sale of property used in that business, is typically considered active and therefore not subject to NIIT.

Material participation, as defined under Internal Revenue Code Section 469, signifies involvement in the business operations on a regular, continuous, and substantial basis. The IRS provides several tests to determine material participation, such as working more than 500 hours in the activity, or performing substantially all of the work in the activity. Another test involves materially participating in the activity for any five of the preceding ten tax years. If the business activity is deemed passive, any gains from the sale of its property would generally be subject to the NIIT.

This exclusion is relevant for business owners selling an interest in an S corporation or partnership. If the owner materially participated in the business, the gain from the sale of their ownership interest may be excluded from NIIT. The intent is to differentiate between income earned from active entrepreneurial endeavors and income from passive investments.

Gains from the Sale of Personal Use Property

Gains from the sale of assets held for personal use are generally not subject to the Net Investment Income Tax. The NIIT specifically applies to “net investment income,” which is typically derived from assets held for investment or activities that constitute a trade or business. Personal use property, such as a personal vehicle, furniture, or jewelry not held for investment purposes, does not fall under the definition of investment property for NIIT calculations.

While these items may generate a capital gain if sold for more than their purchase price, such gains are not classified as investment income under the NIIT regulations. This means that even if a taxpayer meets the modified adjusted gross income thresholds, gains from the sale of personal use property would not contribute to their net investment income subject to the 3.8% tax. This distinction helps ensure the NIIT focuses on investment-related earnings rather than personal asset dispositions.

Reporting Excluded Gains

Taxpayers must accurately report all capital gains, including those excluded from the Net Investment Income Tax, on their annual tax returns. The primary forms involved in this process are Schedule D, Form 8949, and Form 8960.

Schedule D, Capital Gains and Losses, is used to report the sale or exchange of capital assets. Form 8949, Sales and Other Dispositions of Capital Assets, works in conjunction with Schedule D to detail individual capital asset transactions. When a capital gain is realized, it is typically first reported on Form 8949, and then summarized on Schedule D.

For capital gains that are excluded from the NIIT, these amounts are not included in the NIIT calculation on Form 8960. Even if a Form 1099-S is received for a home sale, requiring it to be reported on Form 8949 and Schedule D, the excluded portion of the gain is entered as a negative number on Form 8949 to reflect its non-taxable status. Similarly, gains from active trade or business property are excluded from the NIIT calculation on Form 8960, as they are not considered net investment income. Form 8960 itself is specifically designed to calculate the NIIT, and it includes lines to adjust for gains and losses that are excluded from the net investment income calculation.