Each week in our Ask the Tax Editor series, Joy Taylor, The Kiplinger Tax Letter editor, answers questions on topics submitted by readers. This week, she’s looking at four tax questions from readers on investments, including one on the definition of qualified dividends. (Get a free issue of The Kiplinger Tax Letter or subscribe.)
1. Qualified dividends
Question: I know that qualified dividends are taxed at the same rate as long-term capital gains. But what are qualified dividends?
Joy Taylor: Qualified dividends are dividends paid by U.S. corporations and certain foreign corporations. And there is a holding period rule. The taxpayer must own the stock for over 60 days during a 121-day period that began 60 days before the ex-dividend date. Note that dividends received from investments in real estate investment trusts, or REITs, generally aren’t treated as qualified dividends.
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A foreign corporation must meet one of three requirements for its dividends to be treated as qualified dividends. It must be incorporated in a U.S. possession. It must be eligible for benefits under a tax treaty with the U.S. that has an exchange-of-information section. Or its stock must be readily tradable in the U.S.
Qualified dividends are taxed at long-term capital gains rates of 0%, 15% or 20% (plus the 3.8% net investment income tax for upper-income individuals). Dividends that are not qualified dividends are subject to tax at the regular income tax rates for ordinary income.
2. Sale of a rental home
Question: I am married and own a rental home, which I bought for investment. I plan to sell later this year. Do I qualify for the $500,000 capital gains exclusion when I sell?
Joy Taylor: Unfortunately, no. The gain exclusion you are referring to applies only to sales of principal residences, meaning you live in the home.
Generally, if you have owned and lived in your main home for at least two out of the five years before the sale date, up to $250,000 ($500,000 for joint filers) of your gain when you sell the home is tax-free. Any gain above the $250,000/$500,000 exclusion amount is taxed at long-term capital gains rates of 0%, 15% or 20%, depending on the amount of your taxable income, plus the 3.8% net investment income tax for people with higher incomes.
Since you hold rental property, the gain or loss when you sell is generally characterized as a capital gain or loss. If the property was held for more than one year, it’s a long-term capital gain or loss, and if held for one year or less, it’s a short-term capital gain or loss.
The gain or loss is the difference between the amount realized on the sale and your tax basis in the property.
The capital gain will generally be taxed at 0%, 15% or 20%, plus the 3.8% net investment income tax for people with higher incomes. However, a special rule applies to gain on the sale of rental property for which you took depreciation deductions. When depreciable real property held for more than one year is sold at a gain, the federal tax law requires that previously deducted depreciation be recaptured into income and taxed at a top rate of 25%. This is known as unrecaptured Section 1250 gain, the number of its federal tax code section.
3. Net investment income tax
Question: When I filed my 2025 Form 1040, I had to pay the net investment income tax for the first time. What is this?
Joy Taylor: The 3.8% net investment income (NII) tax was enacted more than 10 years ago under the Affordable Care Act. It applies to single filers with modified adjusted gross income (AGI) over $200,000, joint filers with modified AGI over $250,000, and married people filing separately with modified AGI above $125,000. For this purpose, modified AGI is defined as AGI plus tax-free foreign-earned income.
The NII tax, which is added to the regular income tax, is due on the lesser of NII or the excess of modified AGI over the $200,000/$250,000/$125,000 thresholds. Investment income of trusts and estates can also be hit with the 3.8% NII tax if their 2026 AGI exceeds $16,000 and they have undistributed net investment income.
NII includes what is commonly thought of as investment income: Dividends, capital gains, taxable interest, annuities, royalties and passive rental income. Trade or business income derived through a passive activity is also NII, provided that the business income isn’t otherwise subject to self-employment tax.
Unlike many of the federal income tax breaks and income phaseout levels, the individual income levels for the 3.8% NII tax aren’t indexed to inflation each year. The $125,000, $200,000 and $250,000 modified AGI thresholds have stayed stagnant since the tax first took effect in 2013, despite the high growth in wages, income, and gains from sales of real estate and other investment assets. As a result, more filers are paying this tax each year.
4. Mutual funds
Question: I invest in a taxable mutual fund. Each year, the fund sends me Form 1099-DIV, reporting capital gains distributions, which I include on my Form 1040. When I sell my mutual fund shares, I will have to pay capital gains tax on the appreciation in my shares from the purchase date to the sale date. Isn’t this double taxation?
Joy Taylor: When the fund sells stock within your portfolio, you are taxed on your share of the capital gains from that sale, but the fund manager then reinvests those gains to buy more shares in the fund for you, thus increasing your tax basis in your fund shares. So when you sell your mutual fund shares, you might have capital gains, but you have a higher tax basis because of the previously reinvested capital gains. Thus, your capital gain when you sell your fund shares is lower.
About Ask the Editor, Tax Edition
Subscribers of The Kiplinger Tax Letter, The Kiplinger Letter and The Kiplinger Retirement Report can ask Joy questions about tax topics. You’ll find full details of how to submit questions in each publication. Subscribe to The Kiplinger Tax Letter, The Kiplinger Letter or The Kiplinger Retirement Report.
We have already received many questions from readers on topics related to tax changes in the One Big Beautiful Bill, retirement accounts and more. We will continue to answer these in future Ask the Editor roundups. So keep those questions coming!
Not all questions submitted will be published, and some may be condensed and/or combined with other similar questions and answers, as required editorially. The answers provided by our editors and experts, in this Q&A series, are for general informational purposes only. While we take reasonable precautions to ensure we provide accurate answers to your questions, this information does not, and is not intended to, constitute independent financial, legal, or tax advice. You should not act, or refrain from acting, based on any information provided in this feature. You should consult with a financial or tax advisor regarding any questions you may have in relation to the matters discussed in this article.