The 30 Year Rule: When a Lease Counts as Owning the Land

Not all real estate is owned outright. Ground leases, where one party owns the land and another owns or controls the buildings under a long lease, are common in commercial real estate, around airports, on university and hospital land, and in many city centres.

For 1031 purposes, a leasehold interest is not automatically like kind to owning property outright. But the regulations draw a clear line: a leasehold with 30 years or more remaining, including renewal options, is treated as like kind to a fee interest in real property.

What does the 30 year rule say?

The regulations provide that a leasehold of a fee with 30 years or more to run is of like kind to real estate. That means a long term leasehold can be exchanged for property owned outright, and property owned outright can be exchanged for a long term leasehold.

Leases with less than 30 years remaining are generally not like kind to fee ownership. They may be exchangeable for other leaseholds in some circumstances, but not for owned real estate.

Do renewal options count?

Generally, yes. The remaining term is typically measured including renewal options that the tenant can exercise. A lease with 20 years remaining and two 10 year renewal options is commonly treated as having 40 years remaining for this purpose.

The details of how options are counted, and whether options controlled by the landlord count, can matter, so review the specific lease terms.

When is the rule useful?

Selling a leasehold. An investor who owns buildings on ground leased land, with a long remaining term, can sell the leasehold position and exchange into property owned outright.

Buying a leasehold. An investor can exchange out of owned property into a long term leasehold interest, such as a building on ground leased land, if it fits their investment goals.

Creating a leasehold. In some cases, an owner can grant a long term lease on their property to another party. The treatment of such transactions requires careful analysis.

What about a landlord's interest?

The landlord owns the land subject to the lease, which is a fee interest. Selling the land while it remains subject to a long ground lease is a sale of real property and can be exchanged for other real property.

Leased fee interests, where an investor owns land with a creditworthy tenant under a long ground lease, are themselves a popular type of replacement property, because the tenant typically pays all costs and the land is not depreciable but can be very stable.

What are the risks of buying a leasehold?

• ›The lease will eventually end. At the end of the term, the buildings may revert to the landowner. A leasehold declines in value as the remaining term shortens.
• ›Financing can be harder. Lenders consider remaining term, rent escalations and landlord provisions.
• ›Ground rent increases can reduce returns.
• ›Resale value depends heavily on the remaining term at the time of sale.

A leasehold with 35 years remaining may be exchangeable today, but when you sell it in ten years, it will have 25 years remaining and may not be like kind to fee property for the next buyer who is exchanging.

How does depreciation work?

A leasehold owner can generally depreciate buildings and improvements they own on the leased land. Costs of acquiring the leasehold itself may be amortised over the remaining lease term. The treatment depends on what exactly is acquired.

What should you check?

• ›The exact remaining term and renewal options
• ›Who controls renewal options
• ›Ground rent schedule and increases
• ›What happens to improvements at lease expiry
• ›Landlord consent requirements for transfer or financing
• ›Whether any lease terms could shorten the term

What does an example look like?

An investor owns a restaurant building on land leased from a city under a ground lease with 22 years remaining and two 10 year renewal options held by the tenant. Counting the options, the remaining term is 42 years. The investor may be able to sell the leasehold position and exchange into an apartment building owned outright.

By contrast, an investor holding a leasehold with 18 years remaining and no renewal options would generally not be able to exchange it for a fee interest, because the remaining term is under 30 years.

What to do first

If a lease is involved on either side of your exchange, send the lease to your CPA and attorney before identifying the property. Confirm the remaining term calculation, including options, and whether the interest will be treated as like kind to what you are selling.

Nothing here is tax, legal or investment advice. Leasehold rules depend on the lease terms and your facts. Confirm your position with your advisers before acting.