Do Triple Net Leases Qualify for the Section 199A Safe Harbor?May 23, 2019
Real estate investors, do you have triple net leases? You’re likely wondering if they’re eligible for the Section 199A safe harbor. Well…it’s a bit complicated.
Editor’s Note: This blog has been updated as of January 11, 2021 for accuracy and comprehensiveness.
Attention real estate investors…do you have triple net leased properties? While the safe harbor under Section 199A does not apply to triple net leases, there is still a way out that could work for you. Learn more.
What is the Section 199A Deduction?
Check out our blog, What are the Final Regulations for the 20% Pass-through Deduction?
Essentially the 199A deduction, sometimes referred to as the 20% Pass Through Deduction, allows business owners to take a deduction for up to 20% of their qualified business income (QBI) from schedule C businesses, certain rental businesses and business income from partnerships and S corporations.
What is the safe harbor under Section 199A?
Before the final regulations were issued, taxpayers voiced uncertainty as to whether a rental business qualified as a trade or business under section 199A. To provide some certainty, the IRS released Notice 2019-38 which finalized a safe harbor method under which taxpayers may treat a rental real estate enterprise as a trade or business solely for purposes of the section 199A deduction.
What is a triple net lease?
In the real estate world, a triple net lease is a lease in which the tenant is required to pay a portion, or all, of the taxes, insurance, and maintenance costs for a property.
Does the safe harbor apply to triple net leases?
The section 199A safe harbor does not apply to real estate enterprises that have triple net leases. However, triple net leases (NNN) do not automatically prevent a 199A deduction. A rental real estate enterprise can still be treated as a trade or business for the purpose of section 199A if the enterprise otherwise meets the definition of trade or business under section 162.
What is the safe harbor?
A rental real estate business can meet the safe harbor as long as….
- At least 250 hours of rental services are performed with respect to the rental real estate enterprise
- Separate books and records are maintained for each rental activity (or the combined enterprise),
- The taxpayer maintains contemporaneous records, including time reports or similar documents, regarding 1) hours of all services performed, 2) description of all services performed, 3) dates on which such services are performed and 4) who performed the services.
So, review your activities with your tax advisor before making the assumption that your enterprise with triple net leases would not qualify for Section 199A treatment. If the enterprise (or agents and subcontractors) are regularly and continuously involved in the activity of the property, you may be able to establish that it is a trade or business and is not being operated under a pure NNN lease term.
How can you explain your activities?
Here’s an example:
“XYZ LLC (Landlord) owns and operates commercial rental property in Boston, Massachusetts, which is leased and occupied by three tenants. The Landlord performs maintenance and repairs required in order to keep the structure of the building and all portions of common areas in good appearance and condition. The Landlord enters into service contracts as reasonably determined necessary for the maintenance and repair of equipment such as an elevator which serves the common areas and the building. Forms 1099 are issued to the contractors for services.”
*Also note that the entity will likely be required to issue 1099s if it is claiming to be trade or business qualified for Section 199A.
Questions? Contact us.