QBI, Triple Net Leases and QOZs Under the IRS Big Top
QBI, Triple Net Leases, and QOZs are putting on an edgy, high-dollar show for the Real Estate Community, and I’m the RingMaster introducing these headline acts in this chaotic three-ring circus under the IRS Big Top.
Qualified Business Income, Triple Net Leases, and Qualified Opportunity Zone Funds are in the IRS spotlight high-flying with near-misses and precision catches. All three bear close watching and the show is interactive. The crowd isn’t sure what they’re seeing, when or how to jump in, or what might happen next.
Doing business under the unfinished IRS Big Top
Just about everything with the new tax law is still in flux. After grabbing Proposed Regulations and leaping forward, some real estate investors now find themselves on a precarious ledge after discovering that where these three headliners previously ran parallel they are now splitting jaggedly apart.
The IRS is tossing rescue lines to investors and business owners in the form of shout-outs to file an IRS tax extension until Final Regulations are published or jump in and file according to Proposed Regulations. Either way, taxpayers will be looking over their shoulders at tax possible amendments through 2017.
What’s happening with QBI, Triple Net Leases, and QOZs?
Qualified Business Income: QBI
On Friday, January 18, 2019, during a partial government shutdown and just days before the IRS was to begin accepting tax returns, the IRS released Final Regulations to Section 199A, also known as the Qualified Business Income.
- When the QBI Proposed Regulations (to Section 199A) were issued in late August 2018, they were so complicated that most business owners didn’t realize that precise steps were required by business owners before the end of the year in order to take advantage of the benefits. Many accountants, bookkeepers and tax people did little more than send a canned notice to their client list.
- To identify who qualified to take the Section 199A deduction, the IRS stated “A2: Individuals, trusts and estates with qualified business income, qualified REIT dividends or qualified PTP income may qualify for the deduction. In some cases, patrons of horticultural or agricultural cooperatives may be required to reduce their deduction. The IRS will be issuing separate guidance for co-ops.”
- Things got even more tangled with the failure of Proposed or Final Regulations to define trade or business. The Real Estate Community, specifically those using Triple Net Leases, were again advised that passive investors are not considered to be an active trade or business, and therefore would not qualify for QBI deductions even though they take significant economic risks and may work hard to verify that the tenants pay the taxes, insurances, and maintenance of the leased property, comply with applicable law and otherwise do what tenants are supposed to do.
In October 2018, tax law specified that leasing real estate under a triple-net lease did not qualify as an active trade or business, so each subsidiary (or partners) would need to take a more active role in the management of real property.
However, also progressing through IRS procedures were Proposed Regulations for QOZs. Published in October 2018, these QOZ Proposed Regulations provided that an eligible taxpayer was any taxpayer that recognizes a capital gain, which included individuals, C corporations, partnerships, real estate investment trusts (REITs), S corporations, and trusts and estates are all eligible to participate in QOZs. By default, some would conclude that triple net lease owners participating in QOZs could benefit from QBI deductions within that framework. Assumptions were acted upon in many instances without the benefit of an IFTTT strategy.
Since 2017, and possibly since 2014, investors, developers and specifically real estate investors began positioning themselves to benefit from the Tax Cut and Jobs Act of 2017 and the Qualified Opportunity Zones and Funds tax incentives and QBI deductions.
Final Regulations for QOZ are expected in this spring,
Triple Net Leases: NNN Leases
There are two basic types of real-estate leases which define who pays for the three major ongoing expenses related to owning a property. These expenses are:
- Property taxes
- Building Insurance
A gross lease is the standard lease used by landlords for residential properties. The tenant pays a pre-determined amount for rent, and the above, ongoing expenses are the responsibility of the landlord.
A net lease puts the responsibility of one or more of the above, ongoing expenses on the tenant.
- A single net lease puts the responsibility of property taxes on the tenant,
- a double net lease puts the responsibility of taxes and insurance on the tenant, and
- a triple net lease puts the full burden of taxes, insurance, and maintenance on the tenant.
A triple net lease is often used for commercial property and favored for older buildings or where landlords want a steady, predictable income. Generally, triple net leases have an initial ten-year term, possibly longer, and can include rent increases.
Qualified Opportunity Zone Funds: QOZs
This new attraction was being pranced around in 1986 (and less specifically even earlier) with various tax breaks authorized for “Empowerment Zones” and “Renewal Communities.” By early 2014 excitement had reignited as well-heeled and mega-investors got even more serious about real estate investment tax incentives. By mid-2017 prospective investors had increased the numbers of “economically distressed ” Empowerment Zones from 40 to a rousing 8,700 Qualified Opportunity Zones ripe for Qualified Opportunity Funds.
Preliminary Regulations definition of qualified investors was broad, boiling down to any taxpayer that recognizes a capital gain, such as individuals, C corporations, partnerships, real estate investment trusts (REITs), S corporations, and trusts and estates. Any type of business or property, with the exception of country clubs, massage parlors, and certain “sin” business, was eligible.
The Opportunity Statute became effective on January 1, 2018, with Proposed Regulations set for public comment on January 10, 2019. Depending on the outcome, triple net lease owners could lose qualifications for OZ fund tax incentives as well as QBI deductions.
For owners with hundreds of properties, some in the early years of a standard ten-year triple net lease, this could a devastating event.
Until finalized, Proposed Regulations apply to transactions that occur on or after the date the Proposed Regulations are finalized. Taxpayers may rely on the Proposed Regulations prior to the date they are finalized, so long as taxpayers apply the Proposed Regulations in their entirety and in a consistent manner.
Trade or Business
So, RIGHT NOW we’ve got a group of investors who aren’t completely sure they’re involved in a trade or business who may or may not have been investing as Qualified Investors since 2017. They may know for sure in early spring, shortly after the deadline to have filed their taxes or extensions when the QOZ Final Regulations are set to be published.
What’s the Bottom line?
The new tax laws aren’t for the faint of heart, DIYers, or “flying-by-the-seat-of-your-pants” kind of person. Don’t go it alone. You’re looking at some serious Tax Gaming with emphasis on IFTTT strategy.
Whether you’re a business owner or not, every person should have a proactive, planned tax strategy. Don’t just wait for a tax person to tell you what probably happened last year and then tell you how much you owe.
You can have the same opportunities as my clients have to control your own financial future. I can become your CPA tax specialist and financial business and life goals adviser and you can have the control you need and want.
Our goal is to become part of your overall life and business goal planning team so that you’ll be able to establish your own goals and know that you have a trusted professional on your team. We establish and maintain a personal and business relationship with our clients. Your LIFE is your business and your BUSINESS is your life. We’re here for YOU.
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