USA Ground Lease

[DavidCPA in San Jose]

I have a client (LLC) which has converted a block of rental properties (both residential and commercial) into a ground lease, part way through the 2012 year. At the date the ground lease was executed, the client began receiving a base rent from the lessee, and all rents from existing tennants were transferred to the lessee. The tennants will remain in place potentially through the end of 2013. My question is: what is the status of the depreciated real property? Do I have an "abandonment" loss (ordinary loss) equal to the deprecited basis of the buildings and improvements and, if so, is it at the time the ground lease was executed or not until the buildings are razed by the lessee at some future date? Or do I have "idle property" upon which the client can continue to take depreciation until the buildings are razed, and the lessee is absolutely going forward with construction? Or is it something else altogether? Any input is greatly appreciated.

 

[kirby]

In typical ground lease, lessee obtains the lease then constructs a building improvement on the land. In your case the lessee can immediately earn tenant rental income using the lessor's original building until replaced by a new one. Given that, your original building is not "idle" but in active use until razed for the new one. So i would keep depreciating until razed.

 

[DavidCPA in San Jose]

Thank you. That sounds like the consensus I am hearing; keep depreciating unitl the current buildings are razed. At that point, it looks like it comes down to a determination of whether the capital assets were scrapped or abandoned. Being as the buildings will be demolished upon land still owned by my client, it appears that they may have to be considered scrapped, and thus disposed of similar to a sale or exchange, which will be a capital loss vs. being abandoned, which is an ordinary loss. As this is a family LLC, the loss will flow through on K-1's and will have significantly different consequences as far as deductibility, depending upon the treatment as capital vs. ordinary. Do you have any thoughts on that?

 

[kirby]

IRS abandonment examples typically involve the abandonment of a secured property to the lender when the borrower can no longer pay. This is not your situation.