The Bad News: The Net Investment Income Tax

Code Section 1411 imposed the new “net investment income tax.” The tax is 3.8% of “net investment income” of individuals, estates and trusts above statutory threshold amounts. Net investment income includes

The Net Investment Income Tax is imposed by section 1411 of the Internal Revenue Code. The NIIT applies at a rate of 3.8% to certain net investment income of individuals, estates and trusts that have income above the statutory threshold amounts. Net investment income includes, but is not limited to, interest, dividends, capital gains, passive rental and royalty income, non-qualified annuities, income from businesses involved in trading of financial instruments or commodities and businesses that are passive activities to the taxpayer. To calculate Net Investment Income, investment income is reduced by certain expenses properly allocable to the income

Individuals will owe the tax if they have Net Investment Income and also have modified adjusted gross income over the following thresholds:

Filing Status Threshold Amount
Married filing jointly $250,000
Married filing separately $125,000
Single $200,000
Head of household (with qualifying person) $200,000
Qualifying widow(er) with dependent child $250,000

If gains are not offset by capital losses, the following gains are items taken into account in computing Net Investment Income:

  1. Gains from the sale of stocks, bonds, and mutual funds.
  2. Capital gain distributions from mutual funds.
  3. Gain from the sale of investment real estate (including gain from the sale of a second home that is not a primary residence).
  4. Gains from the sale of interests in partnerships and S corporations (to the extent the partner or shareholder was a passive owner).

The Good News: Partial Relief from the Onerous Results of Related Party Exchange Rulings

In 2009 the Tax Court ruled in the Teruya Bros. v. Comm’r case that exchanges in which a taxpayer acquired replacement property from a related party would be disallowed under the related party rules of Code Section 1031 as a transaction structured to avoid the related party rules of Section 1031 if an accommodator was used. The effect was to virtually eliminate the possibility of acquiring replacement property from a related party.

In Private Letter Ruling 2014-08019 the Service ruled on a build-to-suit exchange structured as a reverse exchange. The seller of the build-to-suit property was a related party. The Service ruled that even though the seller accommodation titleholder who would convey the property to the taxpayer in the reverse exchange was an unrelated party that because there would be no “cashing out” by either of the related parties within 2 years of the transaction that it did not violate the provisions of Code Section 1031 upon which Teruya was based.

This ruling is absurd! It is in direct contravention of Teruya which held in essence that there was “cashing out” because of the sale of the relinquished property by the taxpayer.