Although tenants pay rent to landlords under a leasehold agreement, a leasehold contract does not act like a regular lease. Instead, a leasehold agreement provides the tenant with the right to exclusive use and possession of real estate for an extended period of time.
The landlord relinquishes usage and other rights during that time period, but retains the property deed, or ownership. The leasehold agreement confers benefits to both the landlord and tenant.
A leasehold equates to an interest in the land or building, not the actual land or building. A leasehold, also called a leasehold interest, gives the leaseholder the right to use real estate that the leaseholder does not own for a particular price for a particular period of time, often 20, 50 or 99 years. The leaseholder enters into a ground lease or similar long-term contract that conveys certain rights and clearly delineates the terms. Leasehold improvements, a type of leasehold, refer to real property built or improvements made by the lessee on the landlord’s land.
Tenant Advantage: Reduces Initial Costs
When companies construct buildings, they typically must purchase the land, then construct the building. Often the land contributes significantly to the overall cost of the project and substantially increases the upfront development costs. By entering into a leasehold agreement, the tenant negates the need to purchase the land. By eliminating the land acquisition costs, a company drastically reduces its overall and upfront project costs.
Tenant Advantage: Tax Deductibility
Another tenant benefit of a leasehold interest is the associated tax deductions. A company entering into a leasehold agreement can deduct the rental payments it makes on the underlying land or structure from its federal and state income taxes. If the company owned the underlying property outright, it could deduct the interest payments on the mortgage, but not the principal payments it made.
Landlord Advantage: Tax Reduction
One advantage for the landlord involves gain recognition. If the property-owning entity had sold the property outright, it would need to recognise a capital gain and pay taxes on that gain for the year in which the sale occurred. Entering into a leasehold agreement enables the property owner to avoid a lump-sum tax payment. Instead, the landlord records rental income from the leasehold agreement and pays ordinary income tax on that income.
Landlord Advantage: Ownership Retention
Another benefit of a leasehold for the landlord is retention of ownership of the land or property. If the landlord operates as a large corporation or trust, it may have long-term development plans or a preference to hold the property in its portfolio for future use. A leasehold allows the landlord to retain the right to exploit the property once the leasehold expires.
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