Owning real estate seems fairly straightforward. But depending on where the property is located, ownership can mean a few different things.
While it’s not common everywhere, some states are known to have different types of ownership: fee simple and leasehold. Here’s what you need to know about both.
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What Does Fee Simple Mean?
Fee simple ownership is the absolute ownership of real property, in which the owner holds unconditional power over the land, as well as any improvements — including buildings — that sit on it.
You may pay a mortgage and property taxes, but with fee simple ownership you have the ability to sell the entire property, or parts of it, at your choosing.
What Does Leasehold Mean?
A leasehold is an agreement between the fee simple owner and the lessee, or the person or group that will occupy the property in some form.
“A leasehold is a contractual relationship that the lessee enters into with the property owner — so there is a fixed term on that contract,” says Brad Tisdahl, CEO of Tenant Risk Assessment, a tenant credit consulting firm based in New York City. “The lessee is able to enjoy the use of that land for the purposes outlined in that lease for the term of that lease. In that situation, the lessee is paying rent and sometimes operating expenses … for the use of that land.”
When the term of the lease ends, the rights of use and enjoyment of the property revert back to the owner. This may include any improvements, such as buildings, constructed on the land by the lessee. In cases where the contract specifies what happens to the improvements at the end of the lease, the lessee may remove the improvements instead.
Leaseholds in residential real estate are not particularly common in the U.S. outside of specific states or metro areas, such as Hawaii, in and around Baltimore and parts of Florida, but happen more often in commercial real estate. However, homebuyers appear to be more likely to encounter leaseholds for residential property throughout the United Kingdom and in parts of the British Commonwealth.
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There may be cases where you hear a leasehold described as a “ground lease” between the property owner and the lessee. However, depending on where you live and how the term is used, this may not be correct. A ground lease allows the lessee to develop the property as desired and own the developments for the entire term of the ground lease.
“With a ground lease, you essentially have the rights as an owner of the land and the property or buildings that are on it for the period that you have it, whereas with a leasehold you are going to have significantly more restrictions for what you can and can’t do on that property,” Tisdahl says.
In some places, however, the two may appear more interchangeable. Leaseholds for Maryland residential properties are called “ground rent,” and all properties with ground rent ownership are tracked through an online registry by the Maryland Department of Assessments and Taxation. For properties where the rightful owner cannot be found, lessees may keep ground rent payments in escrow for up to three years in case the landowner reveals him or herself eventually.
What’s the Difference Between Fee Simple and Leasehold Ownership?
The simplest difference between fee simple ownership and a leasehold is whether you own real property in perpetuity. The preference to have fee simple ownership or have a leasehold agreement depends on the individual and the property’s use. In many cases, homebuyers in the U.S. prefer fee simple ownership for the sake of full rights over the property and the ability to sell the property in full.
When the property is being used for a business, a leasehold is often seen as preferred over fee simple ownership. “Most companies and individual (business owners) are not going to be in the position that they want to own the real estate and run the business,” Tisdahl says.
Fee simple ownership requires no rent be paid, though property taxes still must be paid to the local and state government where applicable. A leasehold requires rent be paid to the true property owner, and depending on the terms of the lease, the lessee may also pay property taxes.
How much you pay in leasehold rent varies widely by the type of property, value of real estate and where the property is located. Live Baltimore, a nonprofit working to attract residents to the city and create a healthy housing market, notes that ground rent in the city often ranges between $50 and $150 per year.
In Hawaii, on the other hand, leasehold condos can require a few hundred or even thousands of dollars per month in lease rent, which does not include homeowners association fees for maintenance and upkeep of the community.
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With fee simple ownership, your association with the property lasts as long as you want to keep it, and after your death you can pass on to your next of kin. A leasehold has an established term, though the term can be quite long.
“You might have a leasehold in a multifamily project that has a long term — could be 50 years, could be 100 years,” Tisdahl says. “You could have leaseholds in industrial (properties) that last 15 years or 10 years. You could have leaseholds in commercial and retail that last five to 10 years, so there is some nuance in asset class.”
According to the IRS, a leasehold can only be considered the same as fee simple real estate in a sale of the leasehold if the lease term is 30 years or more.
If you’re trying to sell a leasehold condo with a 15-year term, for example, it’s considered personal property rather than real estate. As a result, it’s often valued lower. You wouldn’t get the same capital gains tax break that you would with selling a property with fee simple ownership. Additionally, your buyer may have a harder time getting a mortgage.
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Fee Simple vs. Leasehold: What You Need to Know originally appeared on usnews.com
