Question: I have two rental properties with triple-net leases. They generate taxable income each year. Can I get the 20 percent deduction for them?
Answer: We don’t have a clear answer for you, so we are going to go with maybe. As you’ll see, we need more information.
A triple-net lease requires the lessee to pay the landlord rent as well as take care of real estate taxes, building insurance, and property maintenance costs. Therefore, in a triple-net lease, the lessee bears all the burdens of ownership, and the landlord usually has little to no involvement in the property management.
Section 199A and Rentals
As we discuss in New IRS Regs: Does Your Rental Qualify for a 199A Deduction, your rental qualifies for the Section 199A deduction if:
- the rental property qualifies as a trade or business under tax code Section 162, or
- you rent the property to a commonly controlled trade or business.
Assuming you can’t use the commonly controlled route, your rental properties need to rise to the level of a trade or business to get your Section 199A deduction. To meet that requirement, you’ll generally need to have regular and continuous involvement with your rental activities. And the proposed regulations require you to look at each rental activity separately when determining whether it is a trade or business—aggregation doesn’t help you with this.
Many triple-net lease rental activities likely fail the regular and continuous activity test and won’t qualify for the Section 199A deduction. For example, in Neill, the Board of Tax Appeals (the precursor to the Tax Court) held that a single property leased on a triple-net basis is not a Code Section 162 trade or business. There’s Some Hope In the preamble to the Code Section 1411 regulations, the IRS gives you other factors to consider when determining whether your rental activity is a trade or business:
- Type of property (commercial vs. residential vs. personal property)
- Number of properties rented
- Day-to-day involvement of the owner or its agent
- Type of lease (net vs. traditional, short-term vs. long-term)
Depending on the particular circumstances of your triple-net lease rental activities, they may rise to the level of a trade or business, even if your involvement with each lease individually is minimal.
Your triple-net lease rental activities face a high hurdle to qualify for the Section 199A deduction. The key reason for a triple-net lease is little to no involvement as a landlord. You need regular and continuous involvement with your rentals for them to qualify as a business eligible for the Section 199A tax deduction. But if your triple-net leases have factors in your favor as discussed in the preamble to the code Section 1411 regulations, you may qualify for the Section 199A deduction. If you really want the Section 199A deduction for your rental activities, you can always modify the lease terms to ensure you have a minimal level of activity, allowing them to rise to the level of a trade or business.