What’s in a name? Recent definitions of a triple net lease across three different programs

Introduction

For many taxpayers engaged in rental real estate activities, one criterion for certain beneficial tax treatments is that the taxpayer be engaged in an active trade or business. Landlords who enter triple net leases with their tenants are generally not considered to be engaged in an active trade or business. As the usage of triple net leases for rental activities continues to grow, it is important to understand how the IRS defines a triple net lease.

Among real estate and tax professionals, a lease will generally be classified as triple net if the majority of the burdens of ownership become the responsibility of the tenant. The most common “burdens” are maintenance of the structure, property taxes, and insurance. In a basic triple net lease, the tenant is responsible for all repairs and maintenance (including the structural components), the timely payment of property taxes and selecting and paying all required insurance. Essentially, a triple net lease provides the only action the landlord must do is collect the rent owed and ensure the tenant’s possession of the property. For this reason, a landlord who enters a triple net lease is not engaged in an active business.

It should be noted that there is no definition of a triple net lease in the Internal Revenue Code (“the Code”) or Treasury Regulations. As such, the IRS has a degree of flexibility to impose its own definition of a triple net lease. Depending on the context, the IRS may impose a more expansive or narrower definition than the three burdens of ownership discussed above. It is important to know which definition the IRS may apply when determining if a taxpayer is deemed to be engaged in an active trade or business.

Because there is no clear definition of a triple net lease, attorneys and landlords should exercise caution when drafting leases. When landlords retain more of the burdens of ownership, there is a lower risk that the lease will be deemed triple net. The following article examines three recent tax programs that shape the definition of a triple net lease.

Triple net lease defined

1. Gulf Opportunity Zone property

In response to the devastating hurricane season of 2005, the Gulf Opportunity Zone Act (“Gulf Act”) was passed to bolster efforts to rebuild areas of Alabama, Louisiana and Mississippi. To encourage investment in impacted communities, the now-repealed legislation provided several tax benefits for taxpayers willing to invest and operate a business within the designated areas.