The CPA's Guide to Ground-Lease Transactions

Your client is about to ask you about this. Here is the whole answer.

Recapture on a land-only sale — land never depreciated

Unchanged

The building’s depreciation schedule after the sale

1031

Fully available on the land proceeds

When an owner monetizes the land under a building with a 99-year leaseback, the tax analysis is cleaner than it first appears — and mostly favorable. The land layer has no depreciation history, so its sale triggers no recapture; the building's basis and schedule continue untouched; the ground rent becomes a deductible operating expense; and the proceeds are exchangeable real property.

The checklist

The six items to confirm, in order.

Item	The analysis
1. Basis allocation	Gain = land price minus the land's allocated basis from the original purchase-price allocation. The allocation controls everything; pull it first.
2. Character of gain	Long-term capital gain (assuming the holding period). No §1250 recapture — that attaches to the improvements, which the client keeps, where it stays dormant.
3. True lease vs. financing	The lease must be a true lease, not a disguised financing: market-consistent rent, no bargain repurchase, genuine transfer of the fee. Institutional 99-year ground leases are drafted squarely on the true-lease side; review the actual terms.
4. Rent deductibility	Ground rent under a true lease is an ordinary and necessary expense of the property — a new deduction the client did not have.
5. Depreciation continuity	The building's depreciable basis, method, convention, and remaining life continue unchanged. Nothing about the land sale touches the improvements' schedule.
6. The 1031 option	The leased-fee is real property; the land proceeds can ride a standard exchange (QI before closing, 45/180). If the client skips the exchange, the tax bill is modest for the reasons above — run both.

The buyer-side footnote (when a client asks about owning the land position instead): land-rent income is generally recharacterized as non-passive under Reg. 1.469-2T(f)(3) when under 30% of basis is depreciable — it will not absorb passive losses. Full detail on our leased-fee buyer page.

Questions, answered

FAQ.

Does selling the land under a building trigger depreciation recapture?

No. Section 1250 recapture attaches to depreciated improvements; land was never depreciable and has no recapture exposure. The recapture the client has accrued stays dormant in the building they keep.

Is the ground rent deductible for the building owner?

Yes, under a true lease — ordinary and necessary operating expense. The true-lease analysis (market rent, no bargain repurchase, genuine fee transfer) should be confirmed against the actual lease terms; institutional 99-year forms are drafted for it.

Does the building's depreciation change after the land sale?

No — basis, method, and remaining life continue exactly as before. Per dollar of equity remaining in the deal, the client's sheltering ratio improves, since the same deductions sit on less invested capital.

Can the land-sale proceeds go into a 1031 exchange?

Yes — the land is real property and exchanges under the normal rules: qualified intermediary in place before closing, 45-day identification, 180-day completion. Model the exchange against the modest straight-sale tax bill; sometimes the simple sale wins.

The CPA’s guide to a ground-lease transaction.