An Introduction

Ground leases are one of the rarer types of contracts in commercial real estate.  Many investors ignore them for the simple fact that they represent ownership of the ground on which a property stands, even though many consider it the safest type of leased investment you can have.

The problem here is that, according to the IRS, the ground cannot be depreciated for taxes because land doesn’t lose value over time. Everything on the land loses value over time and can thus be depreciated, but the land itself cannot.

So, unfortunately, if you purchase a property that’s ground leased to a tenant, you won’t be able to depreciate the land for taxes. However, if you own the property itself, you will be able to depreciate the property instead of the land. Such depreciation can include all changes and improvements made over time.

Let’s explain further and cover ground leases themselves, as they offer other significant benefits as well.

Ground Leases Explained

Ground leases have several key benefits for the landlords, and a few drawbacks as well.

With ground leases, most (if not all) of the responsibilities fall on the tenants, not the landlords. The tenants are the ones who have to pay rent, taxes, renovations, insurance, and all other financings. 

Let’s cover the benefits:

• If you have a great tenant, you will get a stable income stream from them for a long time as ground leases can last between 55 and 99 years. Companies like McDonald’s and other Quick Service Restaurants use ground leases all the time as tenants who sign ground leases get the chance to operate a business on land they would otherwise not be able to buy.

• You can have control over the use and development of the property on the ground lease, so you will be able to depreciate all improvements and renovations if you are the tenant.

• Ground leased properties can always be used in a 1031 exchange where you stand to get several benefits. The main advantage is that you can preserve all equity in a property, which increases the purchasing power you have.

• Ground leases often contain escalation clauses which guarantee eviction rights and increases in rent. The landlord essentially gains the right to increase rent over time and evict the tenant if they default on their obligations (either rent or paying expenses).

Now, let’s cover the disadvantages of ground leases:

• You need to consult a commercial real estate agent for specific information because ground leases can be tricky. If they don’t include several clauses and provisions, landlords can lose control to tenants who make developments on the property.

• Tax implications for the landlords change depending on the location of the property. What’s more, rent is considered income as well, which is why you’ll have to pay taxes on it.

The Bottom Line

All in all, even though land cannot be depreciated, properties on the land certainly can. As the owner of such properties, you stand to gain a lot over long periods. 

As this is undoubtedly a complicated subject, you may need some help if you are considering working with ground leases.  Please feel free to reach us at info@cbicommercial.com if you require any assistance.