Sale Leaseback Transactions

The sale-leaseback strategy provides both tax and financial benefits to both the corporation and the controlling shareholder. The sale and subsequent lease back of an appreciated fixed asset allows the corporation to recognize gains and depreciation deductions, while preserving cash which can be used for operations or invested for higher yields. For the controlling shareholder, IRS Implications on Sale Leaseback Transactions offer an immediate infusion of cash and a reduction of operating debt on the balance sheet. In addition, the lease payments are generally deductible to the extent of business interest.

However, the Internal Revenue Service (Service) will likely scrutinize these transactions to ensure that the taxpayer is not merely using the structure as a disguised loan and that the assets are being used for business purposes. Depending on how the transaction is judged, the taxpayer could be required to pay capital gains taxes, recapture of accelerated depreciation, or have only a portion of the lease payment deductible as investment interest.

IRS Implications on Sale Leaseback Transactions

The Service’s primary focus in making the determination whether to respect a sale-leaseback transaction is its economic substance analysis. This analysis considers three focal points: (1) whether the purported sale and leaseback are multiparty; (2) if the parties’ interests are aligned; and (3) if the interests of the seller/lessee, B Corp, and the buyer/lessor, D Corp, express themselves contractually. Where the interests do not support the form of a sale-leaseback or warrant alternative characterization, such as a section 301(c) distribution and contribution to capital, the Service will not respect the transaction.

A company may need access to the cash tied up in a real estate asset to finance business expansion, reduce debt or return capital to shareholders. A sale leaseback arrangement provides a way to do this while allowing the corporation to continue occupying the asset and deducting rent payments as a business expense.

Sale Leaseback Financing Options are an alternative to traditional debt financing, which can have less lenient loan to value (LTV) and debt service coverage ratio (DSCR) requirements. For example, an LTV and DSCR requirement of 80% or higher may prevent the seller-lessor from obtaining financing for a purchase price that is lower than its carrying amount.

Sale Leaseback Financing Options

In a sale and leaseback arrangement, the seller-lessor retains legal title to the asset. However, the transaction may also contain a right-of-use interest in the underlying asset. It is important to evaluate whether this right-of-use is in place and that control has transferred. See RR 8.7 for guidance on this evaluation.

Some sale and leaseback transactions contain a put option for the buyer-lessor to repurchase the asset at a specified future date. These put options must be evaluated to determine if the transfer is a sale, and thus not reportable as a lease. An analysis should include an assessment of whether the buyer-lessor has a significant economic incentive to exercise the put option, and whether the repurchase price is expected to significantly exceed the market value of the asset at the time of repurchase.

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