What's a Leasehold Property?
Most people own their real estate in a fee simple estate. This is a way of owning property where you essentially have complete and total control over it. There are, however, actually a number of different ways in which you can own real estate. One example which tends to be the most flexible and least expensive is the leasehold estate.
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Definition of Leasehold Property
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Leasehold property is a piece of land which is not owned by its occupant. Much like a rented car, apartment or office space, the owner of the land agrees to let a third party use it for a period of time in exchange for payment. Typically, non-agricultural leasehold interests are leased for decades at a time, allowing the holder of the leasehold property enough time to benefit from the land and to justify the cost of erecting buildings and other improvements which will, ultimately, revert to the owner of the land at the end of the lease.
Typical Leasehold Properties
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Much of America's farmland is farmed on a leasehold basis, where the farmer leases large parcels of arable dirt from a landowner in exchange for either a fixed payment, or for paying a percentage of the crops that the land produces. Non-agricultural leaseholds are typically set up on valuable pieces of land which the owner does not want to sell. One example of this is New York's Rockefeller Center which, until 1985, was actually built on a leasehold interest. Another example is much of the state of Hawaii where a few landowners who link back to the original Hawaiian monarchy control most of the land.
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Investing in Leaseholds
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For cash flow sensitive investors, buying leasehold interests can be a good way to invest in real estate. By buying a long-term lease, you acquire control of the land and the ability to rent it out to someone else at a profit. Although a portion of your rents will go to pay the owner, you would still typically end up with a cash return that is twenty to thirty percent higher than that of a traditionally owned property. Should you choose this route, remember to save a portion of your increased cash flow to compensate for the fact that at the end of the lease, your entire investment will disappear.
Tax Treatment of Leasehold Properties
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Another benefit of buying a leasehold property is that it receives extremely favorable tax treatment. Because a leasehold is considered personal property as opposed to real estate, you can depreciate your entire purchase price, reducing the tax bill on your cash flow. When the ground lease expires, you can record a large capital loss for any remaining basis, saving you even more money. Finally, although leasehold interests are not real estate, the IRS nevertheless allows you to do 1031 tax-deferred exchanges in and out of them, provided the ground lease has at least 30 years of remaining term. This lets you receive high cash flow while still having the benefits of buying and selling without paying capital gains tax.
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References
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