Crafting tax guidance always requires striking a balance between making rules that are administrable and making ones that implement the statute in the way that Congress appears to have intended. For the Opportunity Zone regime, identifying that intent has made the task of writing guidance even more challenging because Congress didn’t directly say what it meant to accomplish. There are a couple of possibilities, but Treasury recently suggested that the general direction of guidance will be to make the tax benefits of the regime as open as possible. That development could also bring subsidiary benefits to residents of Opportunity Zones.
A Treasury official said May 22 that although merely entering into a triple net lease isn’t sufficient to fulfill the requirement that a qualified Opportunity Zone business derive at least 50 percent of its gross income from the active conduct of a trade or business in a qualified Opportunity Zone, if the activities otherwise rise to the level of a section 162 trade or business, triple net leases aren’t a per se disqualifying factor. Treasury made some taxpayers nervous with the April proposed regulations (REG-120186-18), which say that “merely entering into a triple-net-lease with respect to real property owned by a taxpayer is not the active conduct of a trade or business by such taxpayer.”
A triple net lease is a commercial lease under which the tenant pays for the taxes, insurance, and maintenance on the property, as well as the usual items like rent and utilities. That’s the general usage of the term, but it’s not a defined term in the Opportunity Zone rules. It’s a type of lease that is widely used for rentals of storefronts in shopping centers, stand-alone banks and pharmacies, and other retail settings. If Congress wanted to encourage businesses that sell goods and services to the residents of Opportunity Zones, allowing real estate businesses that use triple net leases to meet the active trade or business requirement is consistent with that intent.
The regulations define a trade or business for purposes of section 163(j) by reference to section 162, which is essentially a facts and circumstances analysis. Taxpayers that are planning transactions prefer to have more concrete guidelines than what a facts and circumstances analysis typically provides, however.
A facts and circumstances approach is reasonable because one objective of the Opportunity Zone benefits is to encourage active businesses to invest money and time in disadvantaged geographic regions, but it does have the disadvantage of being somewhat more time intensive for the IRS to audit than a blanket exclusion. The good news for landlords with triple net leases is that if the guidance eventually goes in this direction, they won’t have to spend time reshuffling their transactions to keep them out of triple-net territory; they’ll only need to be able to prove that their involvement in the operation of the business is meaningful.