Double Net Lease (NN): Tax Treatment for Landlords — With a Worked Example

A worked NN lease example — the numbers first

A landlord owns a single-tenant retail strip unit leased on a double net basis to a regional pharmacy chain. Here are the year-one figures:

• Purchase price: $1,400,000 (land $350,000; building $1,050,000)
• Base rent received: $156,000 per year ($13,000/month)
• Property taxes: $24,000 — paid directly by tenant to the county
• Building insurance: $9,000 — paid directly by tenant to insurer
• Maintenance costs (landlord's responsibility): $21,600 — HVAC service contracts, roof gutter cleaning, parking lot sealing, exterior lighting
• Depreciation: Building $1,050,000 ÷ 39 years × 11.5/12 mid-month (placed in service Feb) = $25,641 year one

Schedule E, Part I (simplified):

• Line 3 — Rents received: $156,000
• Line 10 — Repairs: $21,600 (maintenance the landlord paid)
• Line 18 — Depreciation: $25,641
• Net rental income: $156,000 − $21,600 − $25,641 = $108,759

The $24,000 of property taxes and $9,000 of insurance the tenant paid directly appear nowhere on the landlord's return — neither as income nor as a deduction. The landlord's gross income is simply the base rent.

NN vs. NNN vs. gross lease: what each structure means for your return

The three main commercial lease structures allocate costs differently between landlord and tenant, and those allocations flow directly into what each party reports on their tax return.

Gross lease: the landlord receives a bundled rent that covers property taxes, insurance, and maintenance. On the return, the landlord reports the full (higher) rent as income and deducts all three expense categories. More income, more deductions — roughly the same net, but higher gross figures on the return.

Double net (NN) lease: the landlord receives base rent only; the tenant pays taxes and insurance directly. The landlord deducts maintenance costs but cannot deduct the taxes and insurance (since the landlord never paid them). Lower gross income figure, but only one category of ongoing operating expenses to track and deduct.

Triple net (NNN) lease: the tenant pays all three — taxes, insurance, and maintenance. The landlord reports only base rent and has essentially no operating expense deductions. Simplest possible Schedule E: rent in, depreciation out, small number of incidental items.

Using the same property as the worked example above: if the building were under a gross lease at $210,600 (base + costs), the landlord would report $210,600 income and deduct $24,000 taxes + $9,000 insurance + $21,600 maintenance + $25,641 depreciation = $81,241, netting $129,359. Under a NNN lease at the same base rent of $156,000 (the landlord keeps nothing from the operating costs), there would be no maintenance deduction and net income would be $156,000 − $25,641 = $130,359. The NN landlord nets $108,759 — $21,600 less than the NNN case, because the landlord absorbs the maintenance costs under NN.

Reporting NN rental income on Schedule E

A double net lease is still a rental activity and is reported on Schedule E, Supplemental Income and Loss, Part I — the same as any other rental property. The mechanics are straightforward:

Rents received (Line 3): Report the base rent received. If the tenant ever reimburses the landlord for maintenance costs the landlord fronted, include that reimbursement as rental income in the year received.

Taxes (Line 16): Zero. The tenant pays property taxes directly to the taxing authority. The landlord never touches this money and therefore cannot deduct it.

Insurance (Line 9): Zero for the same reason. If the landlord also carries a separate liability or umbrella policy on the property, that premium IS deductible — only the building insurance the tenant pays is excluded.

Repairs and maintenance (Line 10): Fully deductible. All maintenance expenses the landlord actually paid — HVAC service, roof repairs, parking lot maintenance, landscaping, exterior lighting, common-area cleaning — are ordinary and necessary rental expenses under IRC §212 and §162.

Depreciation (Line 18): The landlord depreciates the building at 39 years (commercial), or 27.5 years if residential. Lease structure does not affect the depreciation method or period.

One nuance: if the tenant reimburses the landlord for some maintenance items rather than handling them directly, the reimbursement goes on Line 3 as additional rent and the expense goes on Line 10 as a deductible cost. Both sides wash on net income but increase gross receipts.

Depreciation of a NN commercial property

Depreciation is the most significant deduction for most NN landlords, and the lease structure changes nothing about how it is calculated. A commercial building — whether leased on gross, NN, or NNN terms — depreciates over 39 years, straight-line, mid-month convention under MACRS GDS (§168(c)).

For a NN building placed in service on February 1, the first-year mid-month factor is 10.5/12 of the annual depreciation rate. On a $1,050,000 building, that works out to ($1,050,000 ÷ 39) × (10.5/12) = $23,558 in year one, and $26,923 in years two through 39.

A cost segregation study can reclassify shorter-life components — parking lots, site improvements, interior personal property, specialized equipment — from the 39-year building class into 5-year, 7-year, or 15-year categories. Those reclassified components qualify for bonus depreciation (100% for property placed in service after January 19, 2025). For a NN landlord who owns the building and all its structural components, a cost segregation study done in the acquisition year can convert a portion of the 39-year basis into an immediate first-year deduction — often creating a substantial paper loss even on a fully tenanted NN property.

All depreciation taken — whether straight-line 39-year or bonus from a cost segregation study — is subject to recapture at sale. Section 1250 unrecaptured gain (the cumulative straight-line depreciation on the building) is taxed at a maximum 25% rate. Section 1245 gain on cost-segregated personal property is taxed as ordinary income. The lease structure does not change any of this recapture arithmetic.

Maintenance as a deductible expense

The maintenance costs the NN landlord pays are ordinary and necessary business expenses deductible in the year incurred, provided each item is a repair or maintenance rather than a capital improvement. The distinction matters because capital improvements must be capitalized and depreciated rather than expensed immediately.

Under the tangible property regulations (Treas. Reg. §1.263(a)-3), an expenditure is a capital improvement — and must be depreciated — if it constitutes a betterment (materially adds to value or capacity), a restoration (rebuilds a major component at end of useful life), or an adaptation (changes the property to a new or different use). Routine maintenance that keeps the property in its current working condition is deductible as a repair.

Common NN maintenance examples and how they are likely classified:

• HVAC service contract: Deductible repair/maintenance — routine servicing keeps equipment in working order without adding capacity or value.
• HVAC system full replacement: Capital improvement — this restores a major component and must be depreciated. For a commercial building, §179(f) expensing may be available.
• Parking lot crack sealing and sealcoating: Deductible routine maintenance.
• Parking lot full repaving: Capital improvement — restoration of a major structural component.
• Roof patching: Generally deductible.
• Full roof replacement: Capital improvement — a restored major component must be depreciated over 39 years (or 15 years if treated as QIP in a commercial setting, though roofing itself does not qualify as QIP).

QBI deduction and passive income rules

The qualified business income (QBI) deduction under IRC §199A offers a potential 20% deduction on net rental income, but NN landlords face the same obstacle as NNN landlords: the IRS rental safe harbor in Notice 2019-07 requires 250 hours of rental services per year and specifically excludes properties leased under a triple net arrangement. Most practitioners treat double net leases as functionally similar to NNN for safe-harbor purposes, given that the core characteristic — minimal landlord involvement in operations — is the same.

Without the safe harbor, the landlord must establish that the rental rises to the level of a trade or business under the general Groetzinger standard, which requires regularity and continuity of activity for profit. A passive investor who owns a single NN property and has a property manager handle maintenance rarely meets this standard. A landlord who actively manages multiple properties, handles lease negotiations, directs maintenance contractors, and devotes substantial time to the rental activity has a stronger argument.

For passive activity loss purposes, a NN lease is still a rental activity — passive by default. Net NN losses (typically from depreciation exceeding rent in early years) are passive losses subject to the $25,000-allowance and $150,000-MAGI phase-out (for active participants) or carryforward rules (for purely passive investors). NN income is passive income that can absorb passive losses from other activities.

Selling a NN property: recapture and 1031

At sale, the NN lease structure is irrelevant to the tax calculation — the gain, recapture, and any applicable taxes are determined entirely by the adjusted basis and sale price. The adjusted basis is the original cost minus cumulative depreciation taken (building depreciation and any cost-segregated components).

The gain breakdown: unrecaptured Section 1250 gain (the building's straight-line depreciation) is taxed at a maximum 25%. If a cost segregation study reclassified personal property and bonus depreciation was taken on those components, the recaptured amounts on those components are Section 1245 ordinary income. Any remaining gain above the total accumulated depreciation is long-term capital gain (0%, 15%, or 20% depending on income).

NN properties qualify as investment property for 1031 exchange purposes. Like NNN properties, they are a popular 1031 target because of the low management burden. The deferred gain and accumulated depreciation carry over into the replacement property's basis, and recapture is deferred until the replacement property is eventually sold in a taxable transaction.

Frequently asked questions

Educational information and estimates only. Not tax advice. Tax rules change and vary by situation; consult a qualified tax professional before acting.

Related

• Triple Net Lease (NNN): Tax Implications for Investors
• Depreciation Recapture Calculator
• The QBI Deduction and Rental Real Estate