A land lease, also known as a ground lease, allows you to rent real estate rather than purchase it outright. This arrangement might save you money if you lack the resources to buy the land outright, or if you plan to develop it. Leasing land can result in both federal and state tax benefits.
How Land Leases Work
A tenant may rent either an undeveloped plot of land, or a plot of land with buildings. Often, the tenant will seek a long-term lease for a vacant lot and construct buildings on it. Lease terms can run as long as 99 years. A tenant's purpose in a long-term lease usually is to build income-generating improvements, such as office space, that he can rent to subtenants. If the plot is developed quickly and generates enough income, the tenant might reap a hefty profit during the term of the lease. In most such leases, all tenant improvements belong to the landlord after the lease expires. All of these arrangements must be spelled out in a lease agreement.
Property tax, also known as real estate tax, is assessed by state and local governments against real estate. If the tax is not paid, the taxing authority can place a lien on the property. Eventually, it may foreclose and sell the property to pay the tax. If you own real estate, you are generally responsible for paying the property tax, because you are the party who stands to lose the most if it isn't paid. If you rent real estate, the landlord may agree to pay all or part of the property tax on your behalf.
Depreciation represents a percentage of the value of eligible property that you can deduct from your taxable income each year. The purpose of allowing depreciation deductions is to account for the loss in value of property as it ages. While the value of land itself cannot be depreciated, the value of improvements on land, such as buildings, can be. Since, as the tenant, you will probably own improvements you build during the life of the lease, you will be entitled to take the depreciation deduction even though the landlord owns the land. State governments often allow depreciation deductions as well.
Capital Gains Tax
Capital gains tax is a tax on profit derived from the sale of a capital asset, such as real estate. By renting land under a land lease rather than selling it outright, the landlord avoids liability for taxes on capital gains that he might have realized if he had made a profit on the sale.
You may deduct expenses incurred in maintaining and operating property, within certain limits, as long as the property is used in a trade or business. The deduction belongs to whoever is responsible for incurring these expenses. If the landlord is responsible for landscaping, for example, he may deduct these expenses. If you are responsible for repairs to a factory, you may deduct these expenses. You may also deduct your rental payments, as long as you are running a trade or business. State government also commonly allow these types of deductions. Whoever pays the property tax may deduct those amounts from his federal taxable income.
- Wall Street Journal: Consider Both Sides In Land-Lease Deals
- Internal Revenue Service: Topic 503 -- Deductible Taxes
- Internal Revenue Service: A Brief Overview of Depreciation
- Internal Revenue Service: Topic 414 - Rental Income and Expenses
- Wendel Rosen Black LLP: Pros and Cons of Commercial Ground Leases
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