One of the forgotten tax breaks that homeowners can take advantage of is ground rent. If you want to have a successful real estate career, you need to take every tax advantage that you possibly can. Here are the basics of the ground rent concept and how you can use it to your advantage.
What is ground rent?
Ground rent is an agreement between a home resident and a landlord for the use of the land rather than a domicile. The resident will own the property that is on the land, but the landlord retains possession of the land.
Ground rent is a fixed fee just like a normal rent.
How often is the ground rent concept used?
Ground rent is not used very often in the United States, but it is a technique that is used more in the British Isles and in England. In the US, Maryland and Pennsylvania are the major purveyors of ground rent and its sister transaction, the ground lease.
What are the tax benefits of ground rent?
The major tax break for ground rent is the ability to deduct the rent payments as mortgage interest as long as the lease meets the requirements of the Internal Revenue Service. Ground rents can be either redeemable or nonredeemable based on IRS Publication 936.
What is IRS Publication 936?
Publication 936 is the part of the IRS code that determines whether a ground rent is redeemable or nonredeemable. Both forms of ground rent are available for different types of tax breaks.
Ground rent payments are redeemable if the lease term is more than 15 years and freely assignable; if you have a present and future right to buy the land and end the lease, thereby taking over the property; and if the lessor has an interest in the land primarily to secure the rent payments due to him. Any payment that does not fit all of the above criteria is nonredeemable.
Whether a plan is redeemable or nonredeemable, the payment that is made to end the lease and take full control of the property is never tax deductible.
What does freely assignable mean?
Freely assignable has to do with the parties who may finish out the lease or rent contract. A contract that is freely assignable can be transferred to another buyer or another seller by the respective parties in the middle of the agreement. This has many implications for the negotiation.
If a buyer has an assignable contract, then he may opt out of it before he pays enough money to own the contract, selling the contract to another buyer. Selling a contract is advantageous for the first buyer in a market of increasing home values. If a contract is not freely assignable, then the buyer who makes the original contract with the seller must finish out that contract.
What is a present and future right?
The present and future right to buy the property refers to a buyer’s privilege to close out the loan at any time with a final payment. The buyer must have both the present and future right to buy out, meaning that the ground rent contract is complete, not just a term lease.
Are there any tax benefits to a nonredeemable ground rent payment?
Although you may not be able to deduct your nonredeemable ground rent payment as a mortgage interest payment, you may deduct it as a rent payment. In order to deduct a rent payment from taxes, the payment must be a business expense or a payment for rental property.
Is ground rent a stable way to buy a property with the tax breaks?
Even with the tax breaks, potential buyers must assess the entire process of ground rent before determining a final course of action. Because tenants have relatively little use over the land while they are paying down ground rent, it tends to be a less stable situation than some other kinds of property transfer agreements.
Tax breaks are great if you already have an advantageous payment structure in place. Because taxes are based on a percentage of the total amount that you pay, the primary focus of your efforts as a buyer should be to reduce the total rent, not the taxes. Many people forget this and become so fascinated by the tax breaks that they actually forget to maximize the ROI on their payments.
Take stock of your future plans before committing to a ground rent program as well. If you are not planning to stay in the house for a long time, then you may be better served by another type of rent payment. Ground rent is best reserved for people who are looking to eventually take over the property on which they reside. Make sure that you get a redeemable agreement if at all possible.
2 Point Highlight
Ground rent payments are redeemable if the lease term is more than 15 years and freely assignable; if you have a present and future right to buy the land and end the lease, thereby taking over the property; and if the lessor has an interest in the land primarily to secure the rent payments due to him.
If a buyer has an assignable contract, then he may opt out of it before he pays enough money to own the contract, selling the contract to another buyer.
