Ground Lease

• A ground lease is the type of lease used to rent a parcel of unimproved land. This is property that does not have basic services on it, like water, sewer and electricity. Typically, unimproved land does not have any buildings on it, either. A ground lease usually states that the tenant will construct, at his own expense, a building on the site and may also bring utilities to the site. Because at the end of the term of the lease there will be a building on the property, ground leases define what will happen to the structure when the lease is over.
  
  

Buildings

• Even though any building constructed in a ground lease is done so at the expense of the tenant, it becomes the property of the landlord at the end of the lease. The landlord also may state in the ground lease that the building is to be removed at the end of the lease, and the property returned to its original state. If the structure is to remain after the end of the lease period, though, the ground lease must specify how the tenant will recoup his investment for the building. This can be done either by the landlord paying the tenant the cost of the building (or its current appraised value), or by the landlord allowing the tenant a long-enough lease period so the tenant can completely amortize the cost of the building.
  
  

Regular Termination

• Rents received by the landlord are reported by him as income. The Internal Revenue Service has determined that if the tenant has not fully amortized the cost of the building at the natural termination of the ground lease, then the landlord must report as income the current value of the building minus the amortized amount. The landlord, though, may claim as deductions most expenses he made in regards to the building (e.g., insurance, maintenance, utilities). The tenant may report any nonamortized amount as a loss.
  
  

Early Termination

• If a ground lease does not last for the full lease period but is terminated earlier, then the tax situation becomes more complicated. The landlord will have to report the value of the building as income, but also can report unpaid rent as a loss and any other payments related to the building (e.g., utilities, maintenance and repairs). In some states (like Texas), landlords have what is called a "duty to mitigate," which means that they must take concrete steps to seek a new tenant for the property and therefore minimize their losses. What complicates the situation even further is that rent from a ground lease is considered "passive income" for the landlord, and the IRS imposes certain limits for losses of passive income.