Does the 3.8% NIIT apply to my rental sale, and does a 1031 defer it?

Two numbers decide the bill, and one of them is a lifetime fixture

Section 1411 charges 3.8% on the lesser of your net investment income or your modified adjusted gross income above a fixed threshold, so a large rental gain normally makes net investment income the binding figure.

The thresholds are $250,000 for a joint return or surviving spouse, $125,000 married filing separately, and $200,000 for everyone else. The IRS is explicit that "taxpayers should be aware that these threshold amounts are not indexed for inflation", which is why they have not moved since 2013 while property values have.

For an estate or non-grantor trust, the threshold is the dollar figure at which the top bracket starts, which Rev. Proc. 2025-32 sets at $16,000 for 2026. A trust holding a rental therefore reaches the surtax on almost any sale.

Two groups sit outside it entirely. The Form 8960 instructions state that "the NIIT doesn't apply to nonresident alien (NRA) individuals", and add that a U.S. citizen married to a nonresident alien is treated as married filing separately for the threshold unless a joint election is made.

A passively held rental produces net investment income on the whole gain, recapture included

The IRS lists "gain from the sale of investment real estate" among the items that are net investment income, and it does not carve out the depreciation-driven portion.

That means your 25% layer and your ordinary recapture, if any, both enter the calculation on the way in, even though they are taxed at different rates on the way out.

Rental income while you hold the property is in the same category. It is the sale year that makes it expensive, because one transaction can lift MAGI past the threshold and keep it there for the whole year.

Nonrecognition under §1031 removes the gain from the calculation, not just from the rate

The Form 8960 instructions state the rule in one line: "Gains and losses that aren't taken into account in computing taxable income aren't taken into account in computing NII. For example, gain that isn't taxable by reason of section 121 (sale of a principal residence) or section 1031 (like-kind exchanges) isn't included in NII."

Regulation §1.1411-4 carries a worked example of exactly this. A taxpayer exchanges investment land for other land under section 1031, and the conclusion is that "net investment income for Year 3 does not include any realized gain from the exchange"; the gain enters net investment income only when the replacement is later sold.

So the deferral is not a rate reduction. In the exchange year the sale simply never appears on Form 8960.

A hypothetical joint return: $30,400, $3,040 or $760 on the same sale

Round hypothetical numbers show the spread. A married couple has $300,000 of MAGI before the sale and $20,000 of dividends, and sells a rental at an $800,000 gain.

• Sold outright: net investment income is $820,000, MAGI over the threshold is $870,000, and 3.8% of the lesser figure is $31,160.
• Fully exchanged: the sale is invisible to Form 8960, net investment income is the $20,000 of dividends, MAGI exceeds the threshold by $50,000, and the surtax is $760.
• Exchanged with $60,000 of boot kept: net investment income is $80,000, MAGI exceeds the threshold by $110,000, and the surtax is $3,040.
• In every version the thresholds do not change, which is why a big one-year gain is punished harder than the same gain spread over time.

Deductions properly allocable to the gain come off before the 3.8% is applied

The surtax is charged on a net figure, not on the sale price or even on the gross gain. The Form 8960 instructions describe net investment income as the listed items "reduced by deductions allowed against the income tax that are properly allocable to those items of gross income or net gain."

For a rental sale the useful ones are on line 9. Line 9b takes "state, local, and foreign income taxes you paid for the tax year that are attributable to NII", together with real property taxes paid for the year, subject to the section 164(b)(6) cap where the expense is not tied to a trade or business.

Selling costs are already inside the gain calculation rather than being deductions here, because net gain is computed after them. That makes the state income tax on the sale the largest single reduction for most sellers, and it is also the one most often left off the form.

The 500-hour safe harbor can take the rental out of the surtax altogether

Real estate professionals have a second route, and it survives the sale. Regulation §1.1411-4(g)(7) applies where a real estate professional as defined in §469(c)(7)(B) participates in a rental real estate activity "for more than 500 hours during such year, or has participated in such real estate activities for more than 500 hours in any five taxable years ... during the ten taxable years that immediately precede the taxable year."

Where it applies, the regulation deems both the rental income and "gain or loss resulting from the disposition of property used in such rental real estate activity" to come from an ordinary-course trade or business, which is outside net investment income.

The hours have to be real and documented, and the §469(c)(7)(B) test itself requires more than half your personal services in real property trades and more than 750 hours a year. Confirm with your CPA whether your records actually support it before planning a sale around it.

DST income is usually inside the surtax, and installment payments carry it forward

If you exchange into Delaware Statutory Trust interests, you own an undivided interest in rental real estate you do not manage, so the distributions are ordinarily passive rental income and are net investment income. How DST income is reported each year is set out here.

Seller financing does not avoid the surtax either. The Form 8960 instructions require the adjustment to be computed in the year of disposition, and "the difference between the amount reported for regular income tax and NIIT will be taken into account when each payment is received."

State tax is a separate question with its own answers by state; whether a 1031 defers state capital gains tax is covered here, and state-by-state rules start here.