Triple-net leases are everywhere; and why not? They allow for owners of real property to keep their hands clean while enjoying a return on their capital. With the right tenant—and property—investors can sit back and enjoy a stream of rents just fat enough to offset the debt on the property.
The rent check comes in. The debt payment goes out. The bank account balance goes up.
Few expected that the 2017 Tax Act would target the triple-net-lease. Perhaps the Treasury employees were just disgruntled being called back to work during the government shut down. Whatever the reason, the innocuous sounding Notice 2019-007 interpreting the 2017 Tax Act takes a big bite out of the expected return on triple-net leases under the 2017 Tax Act (“007”).
Here is what you need to know about “007”
- 007 increases the expected tax on commercial leases by 20%, by presumptively denying such leases from the new 199A deduction.199A is generally (if a married couple makes less than $315k)available to all “business income.” Very generally, business income is that income that is not a wage or a capital gain. 199A reduces federal tax by about $6,500 for every $100,000 of income.
- 007 is a safe harbor (perhaps the gold standard) for what owners of commercial leases need to do to get the 199A 20% deduction.
- For a lease to qualify under 007 the owner must show, generally, that 250 hours of effort were devoted to the commercial lease by the owner, employees, or independent contractors for the following activities:
(i) Advertising to rent or lease the real estate;
(ii) Negotiating and executing leases;
(iii) Verifying information contained in prospective tenant applications;
(iv) Collection of rent;
(v) Daily operation, maintenance, and repair of the property;
(vi) Management of the real estate;
(vii) Purchase of materials; and
(viii) Supervision of employees and independent contractors.
4. To get 007 protection, you need to keep a log book and basically swear under oath that you met the rules.
Here are a few humorous thoughts for landlords as to how one may qualify lease income under 007: (I emphasize humorous)
- Execute the lease on the 17th tee, and document in your log book that it took four (4) hours to negotiate and execute the lease. Expected cost: $0, since you were already playing golf anyway. (Pro tip: round out your foursome with your CPA and Attorney for eight (8) additional hours of credit).
- Hire someone to shovel and sweep the property for four (4) hours every week (208 hours). Expected cost: $6.60 (12 stamps). The tenant was already paying for this. As a result of the above negotiations on the golf course, you just hired (one stamp a month) the tenant to do this activity and increased the cost of the lease rate by $2,000.
- Review—in detail—your tax return and balance sheets, monthly (16 hours). Expected cost: $0. You were doing this anyway; right?
- “Manage” the real estate. (I have no idea what this actually entails other than browsing LoopNet weekly for a half hour) (25 hours). Expected cost: $0.
- Stop the auto deposit, and require that your tenant mail you checks, then walk those same checks to the bank. (12 hours, 1 hour a month to check the mail and then go to the bank). Expected cost: (-$600), you gave up your gym membership.
Commercial leases have small margins given the minimal risk, so a 6-7 percentage point swing in taxes could double or eliminate expected returns (we hear that 10 percent ROI is “market”).
Obviously, the above thoughts are illustrative and not intended as legal advice or guidance; you need to talk with your professional advisers ASAP about how to ensure that you get the 199A deduction for your real estate portfolio by taking back some of the active work associated with the lease.
Please feel free to contact Ross P. Keogh* at Worden Thane P.C. to learn more about “007” and the Triple Net Lease.
To call Ross directly, please click here.
*Licensed to practice law in North Dakota, Montana and Wyoming