In real estate, long-term property lease situations (30–99 years, with options for lease extensions) are typically referred to as ground leases. Ground leases and subsequent property transfers can be especially tricky for several reasons.
The specifics of a ground lease are as follows: A landowner leases a piece of property (with no improvements or excavations made to the land) to a tenant. The tenant is allowed to construct a building of any form on the land during the lease agreement.
Improvements and Depreciation
Normally, during fresh construction on untouched land certain excavation changes must be made to prepare the land for subsequent building. The problem is that when excavation takes place the improvements will cause an increase in the property value.
What happens in these situations?
During the specific terms of the ground lease, any improvements made to the land will be owned outright by the tenant. The improvements will be depreciated from the rent. The improvements will transfer to the property owner at the end of the rental term.
In rare situations, the landowner will require the tenant to remove the improvements made to the land that satisfy the construction requirements.
During ground lease situations, the landlords and tenants can potentially reap the benefits in the occurrence of the former situation. Depending on how much value was accrued during the lease term, both parties stand to profit a substantial amount from these improvements.
No Longer Tax-Free
In the past, these transactions weren’t grounds for taxation. This was recognized as a type of tax-free loophole that existed between property owners and renters. However, this changed in most states around 2014, depending on the specific geographic location.
If you’re a current landowner who takes place in the beneficial interest of a land transfer that takes place after a lease of 30 years or more (specifically targeting ground leases), you’ll have to pay taxes at a rate of 50 cents for every $500 of property value added to the land during the leasing term.
In many locations, not only are you required to pay a tax on the added value but an additional transfer tax for the mere creation of a ground lease. Additionally, the situation becomes more complicated when a mortgage is involved on the part of the tenant to finance the construction of the building.
If you’re a landowner or tenant involved in a ground lease, it’s important to be aware of the laws regarding these taxes in your location. Each state is unique in the figures and specifics surrounding these situations, and being aware is critical for compliance.
Turn to the experienced lawyers here at Bell Shah Law when you have any type of real estate attorney questions. We will put our years of experience to work for you and ensure you and your real estate are properly represented.