Sec. 754 and ground leases.

• Author: Pitt, Andrew

A partnership making an optional Sec. 754 basis adjustment for land subject to a long-term ground lease is permitted to adjust the basis of the land but may not allocate the basis adjustment to buildings or other depreciable assets the lessee constructed. A partnership is also not allowed to make an allocation to the leasehold interest to claim an amortization deduction for an accelerated tax benefit.

For estate and gift tax purposes, Regs. Sec. 20.2031-1(b) states that the value of every item of property includible in a decedent's gross estate under Secs. 2031 through 2044 is its fair market value at the time of the decedent's death unless an alternate valuation method is elected.

To determine the fair market value of land subject to a long-term ground lease held by a partnership, an appraiser would consider three recognized methods of valuation: (1) the cost approach; (2) the sales-comparison approach; and (3) the capitalization-of-income approach. The type of property being appraised dictates the method used. The capitalization-of-income approach is the method most frequently used when valuing land subject to a long-term ground lease. The capitalization-of-income approach uses an income projection and converts it into a value by using a discounted-cash-flow technique.

In Friend, 40 B.T.A. 768 (1939), a taxpayer's estate received rental income from properties subject to long-term ground leases. The estate claimed it could deduct from the gross rentals amortization of the capitalized values of the rents to be received under the leases. The estate contended that the properties were separate assets, one being the leasehold estate with a much higher value than the other, the reversionary estate.

The court's opinion stated that

We are not dealing here with the case of a taxpayer who has acquired by purchase or by inheritance a right to receive a periodic sum of money for a term of years. Clearly if a taxpayer had invested money in acquiring such right he would be entitled to deduct from the tents received each year an aliquot part of the cost of his investment; for he would be entitled under the statute to recover back the cost of his investment without being taxed thereon. [Friend, 40 B.T.A. at 771] The Friend court noted that, as in Codman v. Miles, 28 F.2d 823 (4th Cit 1928), cert. denied, 278 U.S. 654 (1929), the courts have held repeatedly that the mere right to receive income is not subject to exhaustion even though the right is limited...