tax benefits

Land Lease: Tax Benefits Explained

Sometimes referred to as ground lease, a land lease is an opportunity to rent real estate instead of purchasing it outright. This arrangement is opted if you don’t have the resources to buy the land outright or if you plan to develop it. A land lease can also result in both federal and state tax benefits for the land-owner and the tenant as well.

How it Works

A lease can be agreed between the land owner and the lessee (tenant) for an undeveloped plot of land or a plot of land with existing structures. In most cases, a tenant will negotiate for a long-term lease for a vacant land and develop the property with buildings or structures. Long term lease can run from 50 years to as long as 99 years. The purpose for a long-term lease is for the tenant to build income-generating structures like office space that can be rented out to subtenants. During the term of the lease, the tenant may be able to reap huge profits from rental income derived from subtenants. At the end of the term, all improvements and structures belong to the land owner.

There are corresponding tax benefits derived from a land lease though each state may have its own set of tax laws which are different from other states. The best way to know what the tax benefits are for each party to the lease is to consult with tax lawyers or tax accountants.

Property Tax

This is also known as real estate tax and is assessed by state and local government against the land or real estate. A lien on the property can be placed by the taxing authority if the property tax due is not paid. Worst case is the government foreclosing and selling the property to pay for the property tax due. The property tax should be paid by the owner of the real estate or the land property. If the land is rented, the land owner may agree to pay all or part of the property tax on behalf of the tenant.

Depreciation

Depreciation is that percentage of the property value which can be deducted from the yearly taxable income. Depreciation deduction is allowed in order to account for the loss in value of the property as it ages. Land value is usually not depreciated, but the value of improvements on the land (buildings or structures) is depreciated. A tenant will own the improvements on a leased land within the lease term. Hence the tenant is entitled to take the depreciation deduction regardless if the landlord owns the land.

Capital Gains Tax

This tax is levied on profit derived from the sale of a capital asset such as real estate. The landlord avoids tax liability on capital gains if he leases out his land instead of selling it outright.

Deductible Expenses

All expenses incurred in maintaining and operating the property within certain limits provided the property is used in a trade or business may be deducted from the tax of the one responsible for incurring the expense. If the landlord took care of landscaping of the property, he may deduct his expenses on the landscaping maintenance. If the tenant took care of the repair expenses, he can use the expenses as deductions from his tax. Rental payments may also be deducted as expenses if a tenant is running a business.
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