Can You Depreciate a Triple Net Lease?
Leases occur in a variety of formats. As with any contract, the parties may tailor the agreement to their specific transaction and requirements. The parties should identify who will be liable for specific property-related duties as a starting point.
In deals involving triple net (or “NNN”) leases, it is important to have everyone on the same page in terms of lease terminology in order to comprehend the unique advantages and dangers connected with this form of lease.
The main types of leases
The renter just pays rent under a gross lease. This is a standard home or apartment rental agreement (they are also used in commercial settings), in which both the landlord and the tenant agree to a specific monthly rate, with the assumption that the landlord would cover the cost of any required repairs, insurance, and taxes. The monthly rent will be greater since the landlord will have “built-in” these fees. If no unforeseen expenditures arise, the landlord may come out ahead in terms of rent surpassing running costs. If there are any unforeseen expenditures, the landlord will be “out of pocket” for them.
In a net lease/single net lease, the tenant pays both the monthly rent and the property taxes. The landlord/owner of the property is still in charge of upkeep and insurance.
The tenant pays a monthly rent, property taxes, and insurance under a double net lease, but upkeep is still the full responsibility of the landlord/owner of the property.
In a triple net lease (sometimes known as a “NNN” lease), the renter is responsible for all property expenditures. Real estate taxes, building insurance, maintenance (including structural repairs), rent, and utilities are all included.
Suppose the leased property is part of a bigger project, such as a shopping mall. In that case, the lease may require the tenant to pay for common area expenditures, such as the parking lot, landscaping, security, maintenance personnel, and elevator/escalator repairs, to mention a few.
The main benefits of triple net lease
The tenant that operates under a triple net lease benefits from visibility into necessary maintenance and, in general, a substantially lower monthly base rental payment. Unexpected or emergency expenditures are passed on to the renter as an “unknown.”
The landlord’s trade-off includes monitoring the property to verify the tenant is following the lease provisions regarding upkeep and repairs and enforcing the lease appropriately.
Suppose the tenant fails to maintain the property in accordance with the lease conditions. In that case, many NNN contracts empower the landlord to inspect the property, make repairs, and charge the renter appropriately.
Whereas tenants under a gross lease payment as part of their monthly rent for “what if” scenarios that may or may not occur (a benefit to those gross lease landlords), tenants under a NNN lease pay for all direct costs associated with the leased property during the term of the lease (which expenses may be lower for new or recently renovated space) or which expenses may be higher for older space (for leased spaces with, for example, older HVAC systems or an older roof).
The landlord benefits from a NNN lease by obtaining a consistent revenue stream without having to calculate potential loss due to tax rises or maintenance problems.
Triple net leases are usually often for a long period of time, 5-10 years, and include rent increase provisions that function as cost-of-living adjustments for the landlord.
The main risks of triple net lease
The expense of emergency or large-scale repairs is obviously the greatest risk associated with a NNN lease for the tenant.
To reduce the risk, a tenant may be able to negotiate repair cost limitations or restrict the systems for which it is accountable (HVAC, plumbing, electrical, etc.).
Prior to signing a lease, a tenant may wish to employ a third-party inspector to assess the property in order to uncover potential high-ticket things (and negotiate the lease appropriately) so that the renter is not “grandfathered in” to pay for severe faults.
Similarly, the largest risk for a landlord under a NNN lease is maintenance and repairs. If a tenant decides that they can “live with” an issue and does not finish repairs, the landlord will be liable for those repairs after the lease agreement expires in order to entice the next renter for the space.
Maintenance may have been postponed for so long at that time that the expense of the repair is exponentially larger than when the issue initially developed.
In the long term, including wording in the lease that allows for scheduled inspections at the landlord’s expense or employing a leasing manager (depending on the number of properties in a landlord’s portfolio) may save money.
Can you depreciate a triple net lease?
Real estate investors, notably triple-net (NNN) lease investors, employ depreciation to recoup the cost of a commercial income property and improve net operating income (NOI).
Depreciation presupposes a reduction in value owing to physical degradation of the property, resulting in large tax benefits for the owner.
While the ground on which your NNN lease building resides does not depreciate, there are other property assets that are eligible.
Depreciation may lower taxable income by thousands of dollars over the course of a year.
As a result, it is crucial to claim the right kind and quantity of depreciation each year in order to optimize your internal rate of return (IRR).
Straight line depreciation, often known as “straight-line basis,” is the simplest technique to evaluate the loss of value of your NNN property over time.
Divide the difference between the property’s cost and its estimated salvage value by the number of years it is expected to be utilized to obtain your depreciation amount, which is a set number in this sort of depreciation.
Nonstructural improvements such as interior and outdoor lighting, heating and cooling systems, and parking lot and landscaping may be depreciated over five, seven, or fifteen years rather than 39 years under cost segregation depreciation.
These are typical nonstructural renovations or assets that may be depreciated at tax time if you own business property.
Unless otherwise specified in the lease, the renter is responsible for all of the following when you possess an absolute NNN lease property.
However, to optimize your own circumstances, consult with a tax specialist.
Replacement of the roof
HVAC system replacement
Brand new windows
Equipment used to keep the property in good condition
Repair costs and service contracts cannot be depreciated, although they may be deducted as expenditures.
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