We signed a ground lease with a 25-year term plus two 10-year renewal options (45 years total), but before the lease term even starts, there's an 'interim term' where we get site access only to run engineering studies and pursue building permits -- we can't occupy or build yet, and we've already had to pay $150,000 to extend that interim due-diligence period once, with more extensions likely. Does that due-diligence interim period count toward the lease's total term for purposes of New York's 49-year Real Estate Transfer Tax threshold, potentially pushing us over 49 years and making the lease taxable?

Plain-English summary

Waldbaum, Inc. ("Petitioner"), as ground lessee, entered into a ground lease dated April 8, 1996, with Sears, Roebuck & Company ("Sears"), as lessor, for premises in Hicksville, New York, intended for a new store within a shopping center. The ground lease's structure separated two distinct time periods. First, an "interim term" -- originally defined as ending on the earlier of 12 months after the lease date, or the issuance (plus any appeal period) of a building permit for Waldbaum's proposed improvements -- during which, per section (26) of the ground lease, Waldbaum had access to the premises solely "for conducting engineering and other feasibility studies, including the obtaining of any and all necessary consents or approvals," without interfering with Sears's ongoing shopping-center operations. Waldbaum could extend the interim term (with the lease providing that any extension would be "deemed to be included within the definition of 'Interim Term' for all purposes"), and construction of the initial improvements couldn't begin until the interim term ended and all requisite permits were obtained.

Second, the actual "Lease Term" -- defined to commence on the earlier of 180 days after the interim term's expiration, or the date Waldbaum opens for business -- runs 25 years, with Waldbaum holding the right to extend for two additional 10-year periods (a maximum term of 45 years).

Waldbaum was unable to secure all necessary governmental approvals within the initial 12-month interim term, so it and Sears executed a series of amendments extending the interim term -- as of the "Third Amendment to Ground Lease," the interim term would run through no later than June 8, 1999, in exchange for a $150,000 "extension payment" from Waldbaum to Sears. That payment was non-refundable unless the Lease Term commenced by December 8, 1999 (at which point Waldbaum would become obligated to pay rent), in which case the payment would instead be credited against rent. The parties further proposed a "Fifth Amendment to Ground Lease" extending the interim term to no later than December 31, 2000, this time without any additional payment required.

Why the interim term doesn't count toward the 49-year threshold. Under Regulation Section 575.7, a lease creates a taxable RETT conveyance only if (1) the lease term plus renewal options exceeds 49 years, (2) substantial capital improvements are or may be made for the lessee's benefit, and (3) the lease covers substantially all the property. The Department held the interim term is NOT part of the lease term for purposes of this 49-year calculation. Instead, the interim term qualifies as an exempt "contract to sell real property...without the use or occupancy of such property" under Tax Law Section 1405(a)(9) -- Waldbaum's limited site access during the interim term, solely to conduct engineering/feasibility studies and pursue permits, doesn't amount to "use or occupancy" of the property. The Department did note that once Waldbaum obtains all necessary approvals and the interim term ends, if it then begins CONSTRUCTION on the premises before the formal Lease Term commences, that construction period WOULD count as "use and occupancy" and be included in the lease-term calculation. But because the Lease Term itself begins, at the latest, 180 days after the interim term ends, the maximum amount of construction-period time that could ever be added to the term is 6 months -- meaning the absolute maximum possible lease term is 45 years plus 6 months (25-year initial term, plus two 10-year renewals, plus up to 6 months of pre-term construction), which is still comfortably under the 49-year threshold. The lease is therefore not subject to the Real Estate Transfer Tax.

What this means for you

A due-diligence period with mere site access for studies and permitting doesn't count as "use or occupancy" -- even if it drags on for years and costs real money to extend

If your ground lease or purchase agreement includes a pre-construction due-diligence or entitlement period where you can access the site only for inspections, engineering studies, and government approvals (not operations or construction), that period is generally excluded from the 49-year lease-term calculation, regardless of how long it runs or how much you pay the landlord to extend it.

Watch the gap between "due diligence ends" and "lease term starts" -- any construction period in between DOES count

If your lease structure allows (or requires) construction to begin before the formal lease term commences, that pre-term construction period is treated as "use and occupancy" and added to your total lease-term calculation -- structure your lease so any such gap is capped at a modest, defined period (here, 180 days) to keep comfortable headroom under the 49-year threshold.

Do the full math across ALL possible extensions and renewal options before assuming your lease is safely under 49 years

This ruling's conclusion depended on precisely totaling the maximum possible term: 25 years initial, plus 20 years of renewal options, plus up to 6 months of potential pre-term construction -- 45.5 years total, safely under 49. If your renewal options or pre-term construction window push the total closer to or over 49 years, the exemption may not apply.

Common questions

Q: If I have to pay a landlord a substantial fee to extend a due-diligence or permitting period under a ground lease, does that period start counting toward the lease's taxable term?
A: Not necessarily -- what matters is whether you have actual "use or occupancy" of the property during that period, not whether money changes hands; a due-diligence period limited to site access for studies and permits stays excluded from the term calculation even if extending it requires payment.

Q: Does starting construction before my lease's formal term begins count against the 49-year threshold?
A: Yes -- once you begin actual construction (as opposed to due-diligence studies), that period is treated as use and occupancy and is included in the lease-term calculation.

Q: How do I know if my ground lease's total possible term (including all renewal options and any pre-term construction gap) stays under New York's 49-year RETT threshold?
A: Add up the initial term, all renewal option periods, and the maximum possible pre-term construction window (the gap between when due diligence ends and the formal lease term begins) -- if that total exceeds 49 years, the lease can become a taxable conveyance.

Citations and references

Statutes, guidance, and case law:

• Section 1402 of the Tax Law
• Section 1401(e) of the Tax Law
• Section 1401(f) of the Tax Law
• Section 575.7 of the Real Estate Transfer Tax Regulations
• Section 1405(a)(9) of the Tax Law

Source

• Landing page: https://www.tax.ny.gov/pubs_and_bulls/advisory_opinions/real_estate_tran_ao_1999.htm
• Opinion: https://www.tax.ny.gov/pdf/advisory_opinions/real_estate/a99_1r.pdf

Original ruling text

New York State Department of Taxation and Finance

Taxpayer Services Division
Technical Services Bureau

TSB-A-99(1)R
Real Estate Transfer Tax
March 1, 1999

STATE OF NEW YORK
COMMISSIONER OF TAXATION AND FINANCE
ADVISORY OPINION

PETITION NO. M990106A

On January 6, 1999, the Department of Taxation and Finance received a Petition for Advisory
Opinion from Waldbaum, Inc., c/o The Great Atlantic & Pacific Tea Company, Inc., 90 Delaware
Street, Paterson, NJ 07503.
The issue raised by Petitioner, Waldbaum, Inc., is whether the period of an "interim term"
of a lease for real property, during which the lessee is conducting due diligence investigations of the
property and is neither paying rent nor otherwise occupying the premises, is deemed part of the lease
term for purposes of determining whether or not the term of the lease is 49 years or more and taxable
for purposes of the Real Estate Transfer Tax imposed pursuant to Article 31 of the Tax Law.
Petitioner presents the following facts. Petitioner, as "Lessee," entered into a ground lease
with Sears, Roebuck & Company ("Sears"), as "Lessor," dated April 8, 1996, for premises located
in Hicksville, New York. The ground lease provided for an "interim term," which was initially
defined in section 1(e) of the ground lease, in part, as:
The period commencing on the date of this Lease and ending on the earlier
of: (i) twelve (12) months thereafter; or (ii) upon the issuance of a building permit
for Lessee's proposed initial Improvements on the Premises by the municipality
having jurisdiction with respect to the Shopping Center and expiration of any time
period within which any appeal therefrom may be taken or challenge thereto may be
asserted. . . .
This definition further provided that in the event that Petitioner was unable to obtain the
requisite permits and approvals prior to the end of the initial interim term, then the Petitioner could
extend the interim term for additional periods by notifying Sears and, in certain instances, making
specified payments to Sears for such extensions. If the interim term were extended, the ground lease
provides that any such extension "shall be deemed to be included within the definition of 'Interim
Term' for all purposes under this Lease."
Construction of the initial improvements to the Premises cannot begin until after Petitioner
has obtained the requisite permits and approvals and the interim term ends.
Section (1)(g) of the ground lease defines the "lease term" of the premises, in part, as follows:

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TSB-A-99(1)R
Real Estate Transfer Tax
March 1, 1999

The Term shall commence ("Commencement Date") on the earlier of: (i) the
date 180 days after expiration of the Interim Term; or (ii) the date Lessee opens for
business on the Premises. The Term shall terminate as of the last day of the month
which is twenty-five (25) Lease Years after the Commencement Date . . . Lessee shall
have the right to extend the Term . . . for two (2) ten-year periods. . . .
Section (2) of the ground lease, entitled "Granting Clause," provides, in part:
In consideration of the obligation of Lessee to pay rent as herein provided,
and in consideration of other terms, covenants and conditions hereof, Lessor hereby
demises and leases to Lessee, and Lessee hereby takes from Lessor, the Premises and
any and all rights and privileges appurtenant thereto, TO HAVE AND TO HOLD
such Premises for the Lease Term, all upon the terms and conditions set forth in this
Lease. . . . (emphasis added)
Section (26) of the ground lease provides, in part:
During the Interim Term, Lessee shall have access to the Premises for
conducting engineering and other feasibility studies, including the obtaining of any
and all necessary consents or approvals, subject to Lessee not interfering with
Lessor's day-to-day business operation on the Shopping Center. . . .
During the interim term, Petitioner, in accordance with section (26) of the ground lease, has
been conducting due diligence investigations regarding the Premises and has been attempting to
obtain the requisite governmental approvals needed to construct the building on the site. However,
because Petitioner was unable to obtain all such approvals within the initial twelve month period of
the interim term, Petitioner and Sears have entered into a series of amendments to the ground lease
extending the interim term. Presently, pursuant to the "Third Amendment to Ground Lease," the
interim term will expire no later than June 8, 1999. In consideration for this extension of the interim
term through June 8, 1999, Petitioner paid Sears $150,000 (the "extension payment"). Pursuant to
the "Third Amendment to Ground Lease," the extension payment is non-refundable unless the lease
term commences on or before to December 8, 1999, and Petitioner thereby becomes obligated to
begin paying rent. If the lease term does commence on or before December 8, 1999, the extension
payment will then be credited against the rent due from Petitioner until the extension payment is
depleted.
Petitioner and Sears would now like to enter into a further amendment to the ground lease
to extend the interim term to a date no later than December 31, 2000, pursuant to a "Fifth
Amendment to Ground Lease." The proposed "Fifth Amendment to Ground Lease" does not require
a payment from Petitioner to Sears in consideration for the further extension of the interim period.

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TSB-A-99(1)R
Real Estate Transfer Tax
March 1, 1999
Applicable Law
Section 1402 of the Tax Law imposes the real estate transfer tax on each conveyance of real
property or interest therein when the consideration exceeds five hundred dollars. The term
"conveyance" is defined in section 1401(e) of the Tax Law. Included in the definition of conveyance
is the transfer or transfers of any interest in real property by any method.
Subdivision (f) of section 1401 of the Tax Law provides, in part:
(f) "Interest in the real property" includes title in fee, a leasehold interest, a
beneficial interest, an encumbrance, development rights, air space and air rights, or
any other interest with the right to use or occupancy of real property or the right to
receive rents, profits or other income derived from real property. . . .
Section 575.7 of the Real Estate Transfer Tax regulations provides, in part:
The creation of a lease or sublease is a conveyance subject to tax only where:
(1) the sum of the term of the lease or sublease and any options for renewal
exceeds 49 years; and
(2) substantial capital improvements are or may be made by or for the benefit
of the lessee or sublessee; and
(3) the lease or sublease is for substantially all of the premises constituting
the real property.
Section 1405 of the Tax Law provides, in part:
(a) The following shall be exempt from payment of the real estate transfer tax:
*

*

*

9. Conveyances of real property which consist of the execution of a contract
   to sell real property without the use or occupancy of such property or the granting of
   an option to purchase real property without with the use or occupancy of such
   property. . . .

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TSB-A-99(1)R
Real Estate Transfer Tax
March 1, 1999
Conclusions
The period of the interim term of the ground lease is not deemed to be part of the lease term
for purposes of determining whether or not the term of the lease is 49 years or more.
The interim term of the ground lease can be characterized, pursuant to section 1405(a)(9) of
the Tax Law, as a contract to sell real property without the granting of the use or occupancy of such
property. The fact that Petitioner has access to the property during the interim term, in order to
conduct engineering and feasibility studies for the purpose of securing building permits and
approvals, does not rise to the level of having the "use or occupancy" of the property.
At the time Petitioner is able to obtain all the requisite permits and approvals for the
construction of the initial improvements on the Premises, the interim term would end. Petitioner
would then be able to begin construction on the Premises. If Petitioner were to begin such
construction, it would then be deemed to have the "use and occupancy" of the property and the time
period during which construction was taking place would be deemed to be part of the lease term for
purposes of determining whether or not the term of the lease is 49 years or more.
However, pursuant to section (2) of the ground lease, the "Lease Term" itself commences on
the earlier of: "(i) the date 180 days after expiration of the Interim Term; or (ii) the date Lessee opens
for business on the Premises" (ground lease, section (1)(g)). Consequently, the maximum amount
of time during which construction was taking place that could be included as part of the lease term
— before the commencement of the actual lease term itself — is 180 days (i.e., six months).
Therefore, because the maximum possible term of the lease would be 45 years, six months (i.e., a
possible six months during construction, plus the 25-year initial term, plus two ten-year renewal
options), the lease is not taxable for purposes of the Real Estate Transfer Tax.

DATED: March 1, 1999

NOTE:

/s/
John W. Bartlett
Deputy Director
Technical Services Bureau

The opinions expressed in Advisory Opinions are
limited to the facts set forth therein.