You operate your professional practice as a C corporation. Your spouse rents your office to your C corporation on a triple net lease. Does your spouse qualify for the Section 199A deduction on the rental income, and if not, what can be done about it?
Under the final IRS regulations, your spouse’s rental activity can qualify for the Section 199A deduction in one of three ways:
- It’s a tax code Section 162 trade or business.
- It meets the Notice 2019-07 rental safe harbor.
- It’s rented to a “commonly controlled” trade or business.
A single triple net lease rental is generally not a tax code Section 162 trade or business.
Your spouse can’t use the new rental safe harbor for a triple net lease property.
Of the three possible paths to the deduction, you don’t have the trade or business or the rental safe harbor available.
The one way your spouse’s triple net lease rental could qualify is if the property were rented to a commonly controlled pass-through trade or business. Since the ownership of one spouse attributes to the other spouse, you’ve met the commonly controlled requirement. So far, so good.
But you fail. In the final regulations, the IRS clarified that you must own the business either directly or through a pass-through entity to qualify for this rule—therefore, your spouse’s rental to your non-pass-through C corporation doesn’t qualify for the Section 199A 20 percent deduction under the commonly controlled rule.
Okay, you are now zero for three. With planning, however, you can change the equation.
You and your spouse have two possible pathways to the Section 199A deduction for this rental property:
- Make an S corporation election for your professional practice.
- Renegotiate the terms of the lease to a traditional commercial property leasing arrangement.