Triple Net Lease and 163(j)

Hi all,

I am working on a rental real estate entity that rents two dealership buildings to a related party. The lease is a triple net lease.If the entity is subjected to the 163(j) limitation, $1.2 million in business interest expense would flow through to the partners as excess business interest expense. The entity has over $25 million in gross receipts due to aggregating gross receipts from another entity under common control. The rental real estate entity cannot elect out of 163(j) using the real property trade or business exception due to the anti-abuse rule (at-least 80% of the property is leased to a trade or business under common control). Now my question - do you think 163(j) applies to a rental real estate entity with a triple net lease?

Under 163(j)(5), business interest expense is defined as any interest paid or accrued on indebtedness properly allocable to a trade or business. Such term shall not include investment interest (within the meaning of subsection (d)).

When 199A came out, it seemed the general consensus among most was that a triple net lease would not be considered a trade or business because 199A pointed to 162 for guidance on what is a trade or business. The main court case that I can find other than Groetzinger is the 1942 Court case of Neill v. Commissioner which essentially stated the mere collection of rent without any other activity was not enough to constitute a trade or business.

Appreciate any thoughts on this.

I dont think there is anything definitive, but the consensus is that a triple net lease, as a general rule, is not a trade or business and does not qualify for the safe harbor.

Does that entity only rent the buildings, and does nothing else(like floor plan financing)?

The entity only rents the building. It collects rent, pays principal and interest on the note and accounting fees for tax preparation.

No CAM accounted for and collected ???

No. The lease agreement requires the lessee to pay for utilities, maintenance, and insurance out of their own pocket. The only item that is considered additional rent is the property taxes.

Is this a self-rental and thus not passive? If so and the partners/members don't materially participate, wouldn't this fall under the investment interest limit of section 163(d)?

Is this a self-rental and thus not passive? If so and the partners/members don't materially participate, wouldn't this fall under the investment interest limit of section 163(d)?

It is a self-rental. I read 163(d)(5) and I don't see rental income listed under 469(e)(1) so I am confused. I wouldn't think a rental property falls under the definition of property held for investment.

(5) Property held for investment For purposes of this subsection—
(A) In general The term “property held for investment” shall include—
(i) any property which produces income of a type described in section 469(e)(1), and
(ii) any interest held by a taxpayer in an activity involving the conduct of a trade or business—
(I) which is not a passive activity, and
(II) with respect to which the taxpayer does not materially participate.

Honestly, I can't quite remember what I was thinking. There was a paragraph in the Lexis Explanation that implied that rental activities that are not passive would be treated as investment.

Investment income that is allowed to be taken into account for purposes of the investment interest limitation does not include interest income taken into account in computing income from passive activities.(17) Although the Congressional Committee reports accompanying the enactment of IRC Section 163(d) state that income from rental real estate activities in which a taxpayer actively participates is not investment income, this was presumably because all rental real estate activities were then subject to the passive activity loss limitations.(18) IRC Section 469(c)(7) now provides that certain rental real estate activities may not be passive activities. Income from activities described in IRC Section 469(c)(7) as to which the taxpayer materially participates should nevertheless remain excluded from "investment income" for purposes of IRC Section 163(d).(19)

Footnote 19 is "See IRC § 163(d)(5)(A)(ii)."

This suggests that is a commonly controlled partnership owns real estate and enters into 80 triple net leases with a C corporation, there is no "trade or business," there is no 199A deduction for the partnership and there is no 163(j) limitation. The rental causes the loss, if any, to be a passive loss and not subject to 163(d) for investment interest limitation.

The activities to create and finance the triple net leases are performed by employees of C corporation. If these activities are viewed as agents of the partnership, might there be the risk that these activities would be attributed to so that the partnership may be viewed to have entered into a "trade or business" and then become subject to 163(j)?