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November 28, 2011

Thinking of redeeming your ground rent?

Louis Wilen, a Montgomery County resident who is a part-owner of a few ground rents, emailed me the other day to share his observations about when (and how) it's worth it for homeowners to buy out the ground rent on their property. I thought you'd be interested, so I'm turning today's blog post over to him in just a moment.

First, Ground Rent 101:

It's a longstanding quirk in our system, one that seems to separate the ownership of homes from the ground underneath them. If your home has a ground rent, you must pay a fee -- usually a relatively small one, twice a year -- to the owner of that investment. Or you can buy it outright, known as "redeeming" it.

Homeowners dealing with ground rent do actually own their land as long as they continue to pay. They officially have a "leasehold" interest in their home and ground, while the ground rent investor has a "reversionary interest." The ground rent works as a never-ending lien.

A Baltimore Sun series about abuses by big ground-rent owners prompted state legislators to pass a series of laws intended to reform the system. One of those changes was recently overturned by Maryland's highest court as unconstitutional because it zapped any ground rent that wasn't registered by owners before the end of September 2010. (A variety of mom-and-pop ground rent owners, the types who weren't seizing houses left and right over small unpaid bills, had complained that they had no idea until it was too late that the state had required registration.)

OK -- that should do. Take it away, Louis:

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With most ground rents yielding 6 percent (and some yielding 12 percent) based on the rent rate divided by their redemption value, most homeowners would save money by redeeming their ground rents, assuming that they have the cash to do so. Paying off a ground rent is essentially equivalent to putting money into a risk-free investment yielding 6 percent. Since there are no risk-free investments yielding 6 percent at this time, the financial benefit of redeeming a ground rent is clear.

Redemption of a ground rent requires payment of recording fees and transfer tax. The amount of the fees and taxes vary depending on the jurisdiction in which the property is located, but as an example, the government fees and taxes to redeem a $100 per year ground rent would be about $100. Also, if the parties need legal assistance to perform a title search, draw up the deed and perform settlement services, there could be additional costs of about $200 to $500.

For homeowners who are refinancing, the benefits are certain and immediate. Ground rent is not tax-deductible, whereas mortgage interest is tax-deductible. Therefore, an astute homeowner who is refinancing would pay off his or her ground rent using the proceeds of their mortgage, effectively converting an interest-only, non-tax-deductible liability into an amortized, tax-deductible loan.

Furthermore, the interest rate on most mortgages nowadays is less than 6 percent, so the interest that they would pay on their mortgage would be less than the effective interest they are paying on the ground that they are renting.

As part of a refinance settlement, the title company sells very profitable title insurance and other settlement services to the homeowner -- so they would likely perform ground rent settlement services at minimal additional cost. I called several title companies and they all said that the additional fee to draw up the ground rent redemption deed and perform the ground rent title search would be little or nothing.

For homeowners who wish to redeem a ground rent outside of a refinance settlement, the transaction costs may make redemption financially unappealing. Any party to the transaction can draw up the deed and avoid the cost of using a title company or lawyer, although that's probably not a wise idea unless they know what it takes to do a title search and write a deed. (If a homeowner knows how to do a title search and write a deed, they've probably already redeemed their ground rent.)

Therefore, as a practical matter, many homeowners will need to hire a real estate lawyer or a title company to handle redemption of their ground rent.

If the State of Maryland would like to see ground rents disappear, perhaps they could put a program in place that would lower the recording fees and transfer taxes for ground rents, and provide some sort of inducement to title companies to provide a uniform ground rent settlement service at a discounted rate.

There's also the ground rent redemption program that was created by the Maryland legislature in 2007. This program provides a 30-year, 0 percent loan -- for those who qualify -- to pay off the ground rent. However, the transaction costs are very high, since they are based on the homeowner paying full charges for a title company to handle the settlement. Therefore, this program is probably not a good deal for most homeowners. It's much less expensive to redeem a ground rent when refinancing.

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Thanks, Louis!

Thoughts, questions, arguments? Comment away.

If you'd like to write a guest post -- either to share expertise or to share an interesting housing-related personal experience -- please drop me a line. Details here.

Posted by Jamie Smith Hopkins at 6:12 AM | | Comments (14)
Categories: Ground rent
        

Comments

I got a lot of good information regarding preparing the deed to redeem my ground rent on www.deeds.com
All in all it was pretty simple. I wonder, do the ground owners have to sell if the homeowner requests to buy?

Just to correct a statement in your post regarding ground rents, the amount a home owner pays in ground rent is most certainly tax deductible as mortgage interest. See IRS pub 530.

Tim, my understanding is that ground-rent owners must sell if the homeowner wants to buy. According to Maryland law, "Except for apartment and cooperative leases, any reversion reserved in a lease for longer than 15 years is redeemable, at the option of the tenant, after 30 days' notice to the landlord." (http://law.justia.com/codes/maryland/2005/grp/8-110.html)

Andrew, thanks very much for that information. Here's the link to publication 530, to save anyone else the Googling: http://www.irs.gov/pub/irs-pdf/p530.pdf

For investors with ground rents it might make more sense to leave the ground rent in place for one simple reason - Depreciation.
The IRS is expecting an 80/20 improvement/land ratio. For example, if you own a $100,000 property without a ground rent that means you can depreciate $80,000 as the improvement (the house itself). Land does not depreciate.
If you own a $100,000 property with a ground rent, that means you can depreciate $100,0000 as the improvement. Remember, you don't own the ground. The ground rent would probably be $96 a year for a property valued at $100,000. This allows an additional $20,000 in depreciation expense over 27.5 years. Even if you are in a low tax bracket, this deduction is worth several times more then the expense of the ground rent.

When I am working with buyers in the city, it seems to me that it's less about wanting to redeem ground rent in order to "save" 6% or anything like that. Most buyers end up looking at it as a cost-benefit analysis. One buyer had a property with $42 yearly ground rent that could be redeemed for $700. She was only planning to live there 5-7 years, so she could pay less than $300 in ground rent during her time of ownership or pay $700 now. She chose to leave the GR intact.

Andrew, you are very sharp. I stand corrected. Ground rent is, indeed, tax-deductible according to IRS Publication 530.

Thanks for providing this helpful tax tip. I expect that many people have overlooked this deduction.

Thanks, Art -- interesting point. And John K., I can definitely see why a buyer would take into account how long they're planning to stay.

Since you haven't seen my posts, i'm sure you've figured out I don't have a subscription & can only use the free page views it may be a while inbetween posts.

My friend wanted to redeme her ground rent & the owner refused to sell & said they wanted $8K for it. He was also one of the ones that didn't register through the city & then claimed he didn't know. But I think they are going to refinance & try to get the ground rent. Any suggestions when the owner says I want $8K?

Hmm, pigtown girl, I don't know if the ground-rent owner can do that. The ground-rent redemption application here -- http://www.dat.state.md.us/sdatweb/groundrent_appl.pdf -- lays out how to calculate the redemption price based on the annual bill, a certain amount of past-due ground rent and when the ground rent was created. But that application is for situations where the ground-rent owner can't be found.

I've sent a question to the state assessors, who run the ground-rent registration program, to see if they can address this specifically.

Ground Rents created prior to April 9, 1884, are not redeemable unless the Lease Agreement explicitly states that it can be so redeemed. The Ground rent owner can ask any price or refuse to sell it altogether. However, the owners of such "Irredeemable" Ground Rents would have had to give notice of their intention to preserve the irredeemability of these Ground Rents as per Real Property Article, Section 8-110.1(d). Otherwise, the statute states that the Irredeemable Ground Rents are hereafter redeemable. So a title search would have to be made to verify the existence of the statutory Notice in the Land Records.

While the penalty for a failure to timely register a ground rent per se has been declared unconstitutional by the Maryland Court of Appeals, I do not believe that the constitutionality of Section 8.110.1(d) was at issue in that case. If this particular issue comes before the courts, it would stand to reason that Section 8.110.1(d) would also be declared unconstitutional for the same reason that the taking of one's property without just compensation for failing to register was declared invalid. In this case, the Legislature is reducing the value of Irredeemable Ground Rents because of a failure to give an additional statutory Notice. Why should owners of such Ground Rents be mandated (under penalty of losing their right not to be forced to sell) to state their intention not to abandon this right under a Lease Agreement that is already recorded in the Land Records?

Don't you think it's poor judgement to put information on your blog that originates from someone who has a conflict of interest? To me, it sounds like Louis Wilen is advocating that people should buy out their ground rents. Of course he want's people to buy their ground rents, since you even stated that he is "part-owner of a few ground rents", therefore he stands to make money from people buying them. In reality it makes absolutely no sense to redeem your ground rent unless you plan on keeping the property for a minimum of 16 years. The redemption value for a $100 annual ground rent is $100/.06 = $1667. Divide that by $100 and you get 16 and 2/3 years. That's just to break even. Obviously, if you plan to own a property for 16 years or more, then it does make sense to redeem the ground rent, but Louis makes it sound like it's a "no-brainer" for anyone refinancing. One of the previous commenters (John K.) also mentioned this fallacy in Louis' though process. Someone please check my logic and tell me if I'm wrong.

Sure, Ace, if he had lots of ground rents. But he's not going to make much as part-owner of a few if they do sell. I thought readers would like to know that if they are thinking of redeeming, they could save money by asking a title company to do it for free as part of a refinancing.

I agree that during a refinance is an opportune time to carry out the redemption process, but I still don't think it's a wise move financially unless an owner plans on staying in that property for an additional 16 years from that point in time. Louis' explanation makes absolutely no sense. He says "Paying off a ground rent is essentially equivalent to putting money into a risk-free investment yielding 6 percent". You don't even begin to yield that 6 percent until the 16th year after you redeem the ground rent, and if you sell before that you actually have a negative yield.

If I buy a house and redeemed the ground at the same time can i then sell the house and keep the ground lease or do i have to sell it with the house?

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About Jamie Smith Hopkins
Jamie Smith Hopkins, a Baltimore Sun reporter since 1999, writes about the regional economy. Her reporting on the housing market has won national and local awards. Hopkins is a Columbia native and has lived in Maryland all her life, save for 10 months spent covering schools in Ames, Iowa.
She trained to become a wonk by spending large chunks of time as a geek and an insufferable know-it-all.
Baltimore Sun articles by Jamie
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