Real Estate Tax Calc
Worked example: 30-year ground lease, full life cycle
A landowner in a commercial district leases vacant land to a retail developer under a 30-year ground lease at $80,000 per year in ground rent. The developer (tenant) constructs a 15,000-square-foot commercial building at a cost of $1,200,000 in Year 1. Here is how the tax picture unfolds across the lease term.
Tenant's annual depreciation (39-year MACRS, mid-month):
$1,200,000 ÷ 39 years = approximately $30,769/year (full-year rate; Year 1 and Year 39 are prorated by the mid-month convention).
Tenant's annual deductions (Years 1–30):
- Ground rent: $80,000 (ordinary business expense)
- Building depreciation: ~$30,769
- Total annual deductions from the lease and building (before other operating expenses): ~$110,769
Accumulated depreciation after 30 years:
30 × $30,769 = approximately $923,077. Remaining adjusted basis in the building: $1,200,000 − $923,077 = $276,923.
At Year 30 — lease expiration and reversion:
The building reverts to the landowner as specified in the ground lease. The tenant receives nothing for the building. The tenant's remaining adjusted basis of $276,923 is an ordinary abandonment loss under IRC §168(i)(1), reported on Form 4797. This loss offsets ordinary income in Year 30 — a potentially significant deduction in the final year of the lease.
Landowner's tax picture over the 30-year term:
- Ground rent income: $80,000 × 30 years = $2,400,000 total ordinary income
- No depreciation deduction (land is not depreciable under IRC §167)
- Deductible expenses: property taxes on the land, mortgage interest on any land debt, professional fees
- At Year 30: inherits a commercial building worth market value at a cost (adjusted) basis of zero — no depreciation deductions available on the inherited building going forward
Landowner's basis in the inherited building after reversion:
The landowner receives the building with a zero adjusted basis. Future depreciation on the building — if the landowner later leases it to another tenant or uses it in business — begins from zero. The landowner will recover $0 of the building's current fair market value through depreciation. If the landowner later sells the building, the entire sales price (less selling costs) is gain, all attributable to appreciation in value since the building was received.
What is a ground lease?
A ground lease (also called a land lease) is a long-term lease of bare land, typically running 50 to 99 years, under which the tenant (lessee) has the right to construct and use improvements on the land during the lease term. At the lease's end, the improvements generally revert to the landowner (lessor) unless the lease provides otherwise.
Ground leases are common for:
- Commercial retail sites where the landowner prefers a steady income stream over selling
- Airports, stadiums, and civic facilities where the government retains land ownership
- Hawaii and New York City residential and commercial development, where fee simple land is scarce or held by institutional owners
- Downtown commercial parcels owned by universities, churches, or family trusts that wish to preserve ownership across generations
Ground leases differ from standard commercial leases in one fundamental way: the tenant owns the building during the lease term. In a standard triple-net lease, the landlord owns both land and building; the tenant occupies and pays operating costs. In a ground lease, the building itself is tenant property — a leasehold improvement at scale — until the lease expires.
Who owns what — and who depreciates the improvements?
The tenant (lessee) who constructs and pays for the improvements owns them during the lease term and claims MACRS depreciation. The IRS follows the "economic owner" principle: the party who bears the cost and economic risk of the improvement depreciates it. For nonresidential commercial buildings constructed by a ground-lease tenant, the recovery period is 39 years under MACRS GDS (or 40 years under ADS).
Landowner (lessor): Owns the land throughout the lease term. Land is not depreciable under IRC §167 — no depreciation deductions, ever. If the landowner also constructs certain improvements or infrastructure as part of the ground lease, those may be depreciable, but ground lease structures typically put all construction cost on the tenant.
Tenant (lessee): Owns the building during the lease term. Depreciates it on the tenant's federal return using 39-year straight-line MACRS, beginning in the year the building is placed in service. Ground rent paid to the landowner is deducted separately as an ordinary and necessary business expense under IRC §162.
If the landowner constructs the building before the ground lease and leases it improved — an unusual but possible structure — the landowner owns and depreciates the building. The more common arrangement, and the one this guide focuses on, is tenant-constructed improvements on the landowner's land.
Ground rent: ordinary income to the landowner, deductible expense to the tenant
For the landowner, ground rent received is ordinary rental income, reportable on Schedule E for individuals or on the business return for entities. Ground rent is not capital gain and does not get favorable rate treatment. The landowner deducts ordinary and necessary expenses — property taxes on the land parcel, mortgage interest on any land-only debt, appraisal and legal fees related to the lease — against the ground rent income.
For the tenant, ground rent paid is a deductible business expense under IRC §162, treated similarly to any other rent payment. It is not capitalized into the building's cost basis. The tenant deducts ground rent in the year paid (cash method) or accrued (accrual method).
Prepaid ground rent is handled differently. If the tenant pays a lump sum or multiple years of ground rent upfront, the economic substance and IRC §178 (treating lease acquisition costs as deferred expenses amortizable over the lease term) may require spreading the deduction over the remaining lease term rather than expensing it immediately. Consult a tax advisor before structuring a ground lease with significant prepaid rent.
What happens when the ground lease expires?
At lease expiration, the tenant's tax position depends on the remaining adjusted basis in the building and what happens to it:
Reversion to landowner (most common): The building passes to the landowner for no consideration. The tenant's remaining adjusted basis is an abandonment loss under IRC §168(i)(1) — an ordinary loss, not a §1231 capital loss — reported on Form 4797. Because the building is not "sold" (no amount realized), the entire remaining basis is deductible. This is typically an ordinary deduction, reducing the tenant's ordinary income in the year of lease termination.
Lease renewal: If the tenant renews, the building continues on the same depreciation schedule. No reversion event occurs, and the tenant continues to deduct both ground rent and building depreciation.
Tenant sells the leasehold before expiration: A tenant can sell its leasehold interest (the remaining lease term plus the building) to a third-party buyer before the lease expires. The sale is a §1231 transaction for the building — the difference between the sales price allocated to the building and the building's adjusted basis is §1231 gain or loss. Any gain on the building that is attributable to accelerated depreciation (Section 1250 unrecaptured gain) is taxed at a maximum 25% federal rate on the individual level.
Landowner buys out the tenant: If the landowner pays the tenant to terminate the lease early, the payment is allocated between the leasehold interest and the building. Payments for the leasehold (the right to use) are §1231 gains; payments that compensate the tenant for the building's remaining basis are ordinary income to the extent they exceed basis, or a loss if below basis.
Ground leases and 1031 exchanges
A ground lease tenant's leasehold interest qualifies as like-kind real property for purposes of a 1031 exchange if the remaining lease term — including all renewal options that the tenant has the right to exercise — is 30 years or more at the time of the exchange. This threshold comes from Reg. §1.1031(a)-1(c), which treats a leasehold interest with at least 30 years remaining as like-kind to a fee simple interest in real property.
Implications:
- A ground lease tenant who built a $5 million building and held the leasehold for 20 years — now with 25 years remaining — may not exchange out of it into fee simple property on a tax-deferred basis, because the remaining term is less than 30 years.
- A landowner selling the land (a fee simple interest) can exchange into another fee simple property or into a leasehold with 30 or more years remaining. The landowner is not exchanging the building — just the land — and the zero-basis building becomes the new owner's asset.
- When a ground lease tenant sells the leasehold with 30+ years remaining, the buyer steps into the tenant's position: same lease terms, same ground rent, and the buyer's basis in the building is the purchase price paid, which begins a new depreciation schedule for the buyer from the date of acquisition.
Subleasing and financing considerations
Ground lease tenants often sublease the building (not the land) to operating tenants under separate commercial leases. The ground lease tenant then has two sets of deductions: ground rent paid to the landowner and normal operating expenses, against sublease rent income received from subtenants. The tax mechanics are those of a standard commercial landlord for the sublease layer, with the added ground rent deduction on top.
For financing, lenders who lend to a ground lease tenant are secured by the leasehold interest — not the land. Because the leasehold expires and the building reverts, most institutional lenders require that the remaining lease term exceed the loan amortization period by at least 10 to 15 years. A building loan with a 25-year amortization on a leasehold with 30 years remaining is at the outer edge of lender comfort.
Most ground lease financing also requires a recognition agreement (sometimes called a "non-disturbance and attornment" agreement) from the landowner, which provides that if the tenant defaults on the loan, the lender can cure the ground lease default and step into the tenant's position to protect the building collateral. Without a recognition agreement, a lender's security interest in the leasehold can be extinguished if the tenant defaults on the ground lease — a risk that most lenders are unwilling to accept.
Frequently asked questions
Who depreciates the building in a ground lease?
The tenant (lessee) who constructs and pays for the building depreciates it over 39 years for nonresidential real property. The landowner cannot depreciate the land and receives no depreciation deduction. If the landowner builds and then leases to the tenant (less common), the landowner depreciates the building.
Is ground rent deductible by the tenant?
Yes. Ground rent paid to the landowner is a deductible ordinary business expense under IRC §162 for the tenant. It is not capitalized into the building's cost basis, though prepaid multi-year ground rent may need to be spread over the lease term under IRC §178.
What happens to the tenant's building when the ground lease expires?
If the building reverts to the landowner at expiration, the tenant claims an ordinary abandonment loss equal to the remaining adjusted basis under IRC §168(i)(1), reported on Form 4797. The landowner inherits the building at a zero adjusted basis — no cost to the landowner, and no depreciation deductions available on the inherited building going forward.
Can a ground lease interest qualify for a 1031 exchange?
Yes. A leasehold interest with 30 or more years remaining (including all renewal options the tenant holds) is treated as like-kind to a fee simple real property interest under Reg. §1.1031(a)-1(c), making it eligible as relinquished or replacement property in a 1031 exchange.
Is ground rent income taxable to the landowner?
Yes. Ground rent received by the landowner is ordinary rental income, reportable on Schedule E. The landowner can deduct ordinary and necessary expenses such as property taxes on the land, mortgage interest on land debt, and professional fees — but cannot depreciate the land itself.
How does a ground lease affect financing for the tenant?
Lenders secured by a leasehold estate typically require the remaining lease term to exceed the loan amortization by 10–15 years, and most require a recognition agreement from the landowner that lets the lender cure a ground lease default and preserve its collateral if the tenant defaults on the loan.
Educational information and estimates only. Not tax advice. Tax rules change and vary by situation; consult a qualified tax professional before acting.