When genuine estate specialists refer to a ground lease, they usually mean a long term (usually 30-99 years, including options to extend) lease pursuant to which a residential or commercial property owner rents land (but not enhancements) to a tenant, and the renter is permitted to build a building on the land during the lease term. During the ground lease term, the renter will generally own and diminish the improvements. At the end of the term, ownership of the improvements usually transfers to the residential or commercial property owner, or the ground lease might require the ground occupant to remove them. Ground lease property owners and tenants can each gain gain from the arrangement; however, versatility is not typical of ground leases.

They Can Tax That?

A few states, counties and municipalities around the country tax the transfer or task of a tenant's interest in a ground lease. Now, however, thanks to some recent judgments by the City of Chicago Department of Finance, in Chicago, you'll be paying early and often for the benefit of not just moving a ground lease, but getting in into one.

The State Gets Its Piece of the Pie (or Dirt)

The State of Illinois, like lots of states, enforces a tax on the "privilege of transferring ... a useful interest in real residential or commercial property located in Illinois, at the rate of 50 cents for each $500 of value or fraction of $500 mentioned in the statement". (35 Ill. Comp. Stat. 200/31 -5 and 200/31 -10)A useful interest "consists of"the lessee interest in a ground lease (consisting of any interest of the lessee in the associated enhancements )that offers a regard to thirty years or more years when all alternatives to restore or extend are consisted of whether or not any part of the term has ended. "(35 Ill. Comp. Stat. 200/31 -5. )The Illinois Department of Revenue holds that the transfer tax uses to the project of the ground lease by a tenant, but not to the issuance or production of ground leases ... so a minimum of you are not taxed from the start.

The City of Big Shoulders Gets a Bigger Piece of the Pie (or Dirt)

Chicago also taxes the "the privilege of transferring title to, or beneficial interest in, real residential or commercial property situated in the city, whether the arrangement or contract offering for the transfer is gotten in into the city", and, like the State, Chicago specifies an advantageous interest in real residential or commercial property as "the lessee interest in a ground lease (including any interest of the lessee in the related improvements) that offers for a term of thirty years or more years when all alternatives to renew or extend are included, whether or not any part of the term has expired" (Chicago Municipal Code § 3-33-020(A)( 2 )). However, as the City of Chicago's monetary scenario has actually deteriorated, Chicago has actually taken an increasingly broad view of both what constitutes a ground lease and when the tax on a ground lease is due. On December 16, 2014, the City of Chicago Department of Finance released Real Residential or commercial property Tax Ruling # 5, which supplies that by the simple act of granting a renter the right to use genuine residential or commercial property under a long-lasting ground lease, a proprietor is transferring a taxable "advantageous interest in genuine residential or property" within the significance of the Chicago Municipal Code. Simply put, you have to pay a transfer tax for the creation of a ground lease, and not simply the assignment of an occupant's interest in a ground lease. Moreover, on January 19, 2020, the City of Chicago Department of Finance released Real Residential or commercial property Tax Ruling # 6 which provides that, in the eyes of the City, the truth that the lease consists of not only the land but likewise a building does not prevent the lease from being thought about a ground lease (interested to see what the City does rule out to be a ground lease ...).

So What's the Damage?

So now that we know that, a minimum of in Chicago, both the development of a ground lease and the transfer of an occupant's interest in a type of lease that many property experts would not consider a standard ground lease are taxed, how do we understand when the tax is due and just how much it is? Chicago's City Code informs us that the taxable transfer cost is "the factor to consider furnished for the transfer of title to, or useful interest in, real residential or commercial property, valued in cash, whether paid in money or otherwise, including money, credits and residential or commercial property, figured out without any deduction for mortgages, liens or encumbrances ...". According to Ruling # 6, if the consideration provided consists of amounts that are not for the lessee's interest in real residential or commercial property then those amounts might be deducted for functions of determining the taxable transfer cost. But what does this mean with respect to a lease? Ruling # 6 offers guidance.

For an existing taxable ground lease, the transfer cost is the consideration paid to the original lessee, by the new lessee, for the transfer of the rest of the lease.

On the other hand, when a new taxable ground lease is being produced, the transfer cost is the swelling sum that represents today economic equivalent of the lease payments to be made throughout the term (excluding any choice periods that have actually not yet been worked out). A discount rate of 110% of the Long-term Applicable Federal Rate (AFR), based on month-to-month intensifying for purposes of Section 1274(d) of the Internal Revenue Code that is in effect for the calendar month in which the transfer occurs, is utilized to accomplish this.

Because determining the present value of future lease payments can often involve uncertainty - for example, if the amounts of those payments will depend upon future events, such as gross earnings or other variable efficiency steps-- Chicago allows taxpayers the option of postponing payment of the tax up until the matching lease payments are made. Alternatively, a taxpayer can pay tax based upon a transfer cost equal to the estimated reasonable market value of the real residential or commercial property to be leased (as most just recently accredited by the Cook County Board of Review).

If the lease requires the lessor to include improvements after the time of the transfer, it gets even more complex. The City allows the taxpayer to: (a) pay tax at the time of the transfer based on the estimated FMV of the land plus the lessor's approximated cost of providing the additional enhancements (note, though that this estimate is subject to investigate, and if the actual cost varies 10% or more from the estimate, then the taxpayer and the City reconcile), or (b) pay tax based upon the estimated FMV of the land as unaltered and after that, after the improvements are added, file an extra declaration and pay any extra quantity due.

Financing a Ground Lease Interest - You Can Mortgage That?

Financing a renter's ground lease interest raises a number of complicated questions, the primary of which is whether the lease enables a leasehold mortgage and whether the ground landlord must subordinate its interest in the ground lease to a tenant's leasehold mortgage. When markets pull back, the ground property owner might want to permit the subordination of its interest for the residential or commercial property's redevelopment. If the lending market needs a mortgage on the landlord's fee interest in the land, perhaps the occupant can approve the property owner a taking part interest in the task? Or, the ground proprietor might accept the encumbrance of the land with a mortgage if the ground tenant can provide equity or the lending institution restricts the maximum lien exposure to the land. With a determined ground renter and ground proprietor, there is more than one way to fund a ground lease offer.

Being Flexible - Can I Build That?

If there are building and construction arrangements in the ground lease and building is total, the provisions most likely pondered the building of the project's existing structure-and restricted the ground occupant's capability to develop anything various. For occupants, the hope is that the ground lease contains a system by which a ground occupant can start 'from the ground up' and redevelop the residential or commercial property with the landlord's sensible permission as a matter of right under the ground lease.

But even if funding and the ground renter's ability to rebuild the enhancements on the residential or commercial property are not at issue, some ground leases consist of usage limitations that could prevent the ground occupant's plans to redevelop. The ground property owner might own surrounding land and want to keep some or all of the use constraints set forth in the ground lease in place. If the greatest and finest usage of the residential or commercial property contravenes the use limitations stated in the ground lease, or more notably, the ground landlord's interests in operating its surrounding residential or commercial property, the ground tenant could be stuck in the mud. It is in the ground landlord's interest to effectuate a reuse of the residential or commercial property, though, as any enhancements to the job are likely to go back to the ground proprietor at the end of the ground lease.

If issues with usage limitations can be overcome, adequate term on the ground lease remains and financing is readily available, either through a leasehold mortgage or pseudo joint venture with the ground property owner, an occupant's ground lease can be redeveloped. However, if a ground tenant tries to appoint its leasehold interest to off-load area in the wake of the COVID-19 pandemic or for any other market downturn, as the State of Illinois' financial straits grow significantly alarming, it will be interesting to see whether the State follows the lead of its largest city and expands its scope of which leases it taxes to consist of the creation of a ground lease. and at what points in the life of those leases it taxes them. Let us hope not.