Difference between revisions of "Sales-Leasebacks: The Devil Remains In The Details"

Latest revision as of 21:40, 10 October 2025

A sale-leaseback takes place when a company sells an asset to a lessor then and leases it back. The leaseback may be for the entire possession or a part of it (as in realty) and for its entire staying useful life or for a much shorter period.


Sale-leaseback accounting addresses whether the asset is derecognized (gotten rid of) from the seller's balance sheet, whether any profit or loss is acknowledged on the sale and how the leaseback is capitalized back on the seller-lessee's balance sheet.


Under FAS 13 and ASC 840, if the present value of the leaseback was 10% or less of the possession's fair market price at the time of the sale, any profit arising from the sale might be acknowledged entirely and the leaseback would remain off the lessee's balance sheet due to the fact that the resulting leaseback would be dealt with as an operating lease.


If the leaseback was greater than 10% and less than 90%, a gain could be recognized to the degree it surpassed today worth of the leaseback, while the leaseback remained off the balance sheet because it was reported as an operating lease. In essence any gain that was less than or equivalent to the PV of the leaseback was delayed and amortized over the leaseback term. The gain would essentially be acknowledged as a reduction to offset the future rental cost.


For leasebacks equivalent to or higher than 90%, the possession would stay on the lessee's balance sheet, no gain might be reported and any proceeds would be dealt with as loans to the lessee from the purchaser.


Under FAS 13 and ASC 840, sale-leasebacks of genuine estate and equipment thought about integral to realty consisted of an added caveat. If the leaseback consisted of any type of repaired cost purchase option for the seller/lessee, it was ruled out a sale-leaseback.


Therefore, even if the sale was a valid sale for legal and tax functions, the possession stayed on the lessee's balance sheet and the sale was dealt with as a financing or loaning against that property. The FASB's position was based upon what was then called FAS 66 "Accounting for Sales of Real Estate" which highlighted the many distinct methods in which property sale transactions are structured. Additionally, the FASB noted that many such realty transactions resulted in the seller/lessee buying the asset, thus supporting their view that the sale-leaseback was merely a type of financing.


Sale-leasebacks Under ASC 842


Accounting for sale-leaseback deals under ASC 842 lines up the treatment of a possession sale with ASC 606 referring to revenue recognition. As such, if a sale is recognized under ASC 606 and ASC 842, the full or loss might hence be recorded by the seller-lessee.


ASC 842 is said to in fact enable more sale and leaseback deals of property to be thought about a sale under the new set of standards, supplied the sale and leaseback does not include a repaired rate purchase option.


On the other hand however some transactions of properties aside from real estate or devices essential to property will be thought about a stopped working sale and leaseback under ASC 842. As mentioned above, those sales and leasebacks that include a fixed rate purchase option will no longer be considered a 'successful' sale and leaseback.


A failed sale-leaseback happens when


1. leaseback is classified as a financing lease, or
2. a leaseback includes any repurchase alternative and the possession is specialized (the FASB has suggested that real estate is generally thought about specialized), or
3. a leaseback includes a repurchase option that is at other than the possession's reasonable worth figured out "on the date the choice is worked out".


This last item implies that any sale and leaseback that consists of a set cost purchase alternative at the end will remain on the lessee's balance sheet at its full value and categorized as a fixed property rather than as a Right of Use Asset (ROUA). Despite the fact that an asset might have been lawfully sold, a sale is not reported and the property is not removed from the lessee's balance sheet if those conditions exist!


Note likewise that extra nuances too numerous to address here exist in the sale-leaseback accounting world.


The accounting treatments are discussed even more below.


IFRS 16 Considerations


IFRS 16 on the other hand has a somewhat various set of requirements;


1. if the seller-lessee has a "substantive repurchase option" than no sale has happened and
2. any gain acknowledgment is restricted to the quantity of the gain that associates with the buyer-lessors residual interest in the hidden property at the end of the leaseback.


In essence, IFRS 16 now also prevents any de-recognition of the property from the lessee's balance sheet if any purchase option is provided, besides a purchase alternative the worth of which is determined at the time of the workout. Ironically IFRS 16 now needs a limitation on the quantity of the gain that can be recognized in a comparable fashion to what was allowed under ASC 840, particularly the gain can just be acknowledged to the degree it goes beyond the present value of the leaseback.


Federal Income Tax Considerations


In December 2017, Congress passed and the President signed what has become understood as the Tax Cuts and Jobs Act (TCJA). TCJA offered for a renewal of bonus offer devaluation for both brand-new and secondhand properties being "used" by the owner for the very first time. This implied that when a taxpayer first put an asset to utilize, they could claim reward devaluation, which begins now at 100% for possessions which are acquired after September 27, 2017 with certain restrictions. Bonus depreciation will begin to phase down 20% a year starting in 2023 till it is eliminated and the depreciation schedules revert back to requirements MACRS.


Upon the passing of TCJA, a question occurred regarding whether a lessee might claim reward depreciation on a rented asset if it got the property by exercising a purchase choice.


For instance, presume a lessee is renting a possession such as a truck or maker tool or MRI. At the end of the lease or if an early buyout option exists, the lessee might work out that purchase option to get the possession. If the lessee can then right away write-off the worth of that asset by claiming 100% bonus offer depreciation, the after tax expense of that property is instantly decreased.


Under the present 21% federal business tax rate and following 100% bonus offer devaluation, that indicates the possession's after tax cost is lowered to 79% (100% - 21%). If however the property is NOT qualified for bonus devaluation because it was previously utilized, or need to we state, utilized by the lessee, then the expense of the property begins at 100% decreased by the present worth of the future tax reductions.


This would suggest that a leased asset being purchased might lead to an inherently greater after-tax expense to a lessee than a possession not rented.


Lessors were worried if lessees could not claim perk devaluation the value of their assets would end up being depressed. The ELFA brought these issues to the Treasury and the Treasury reacted with a Notice of Proposed Rulemaking referenced as REG-104397-18, clarifying that the lessee can claim perk depreciation, supplied they did not formerly have a "depreciable interest" in the property, whether depreciation had ever been declared by the seller/lessee. The IRS asked for discuss this proposed rulemaking and the ELFA is reacting, nevertheless, the last guidelines are not in place.


In numerous leasing deals, seller/lessees build up a variety of similar properties over a time period and then participate in a sale and leaseback. The present tax law permitted the buyer/lessor to deal with those possessions as brand-new and therefore under previous law, received bonus devaluation. The provision followed was commonly called the "3 month" whereby as long as the sale and leaseback took place within 3 months of the property being placed in service, the buy/lessor could likewise claim perk devaluation.


With the introduction of bonus depreciation for used assets, this guideline was not necessary since a buyer/lessor can claim the benefit devaluation despite for how long the seller/lessee had actually formerly used the property. Also under tax guidelines, if a possession is gotten and then resold within the very same tax year, the taxpayer is not entitled to declare any tax depreciation on the property.


The introduction of the depreciable interest concept throws a curve into the analysis. Although a seller/lessee may have owned an asset before participating in a sale-leaseback and did not claim tax devaluation due to the fact that of the sale-leaseback, they likely had a depreciable interest in the property. Many syndicated leasing deals, particularly of automobile, followed this syndication approach; many assets would be accumulated to achieve a crucial dollar worth to be offered and rented back.


Since this writing, all properties originated under those scenarios would likely be ineligible for bonus offer devaluation need to the lessee exercise a purchase option!


Accounting for a Failed Sale and Leaseback by the lessee


If the transfer of the asset is not considered a sale, then the possession is not derecognized and the earnings gotten are dealt with as a funding. The accounting for an unsuccessful sale and leaseback would be different depending on whether the leaseback was identified to be a financing lease or an operating lease under Topic 842.


If the leaseback was determined to be a finance lease by the lessee, the lessee would either (a) not derecognize the existing asset or (b) tape-record the capitalized worth of the leaseback, depending upon which of those techniques created a higher property and offsetting lease liability.


If the leaseback was identified to be an operating lease by the lessee, the lessee would derecognize the possession and delay any gain that may have otherwise resulted by the sale, and then capitalize the leaseback in accordance with Topic 842.


Two cautions exist concerning how the financing part of the failed sale-leaseback should be amortized:


No negative amortization is permitted Essentially the interest expense acknowledged can not go beyond the portion of the payments attributable to principal on the lease liability over the shorter of the lease term or the financing term.
No integrated loss might result. The bring value of the underlying possession can not surpass the financing commitment at the earlier of completion of the lease term or the date on which control of the hidden possession transfers to the lessee as buyer.


These conditions might exist when the failed sale-leaseback was triggered for example by the presence of a fixed rate purchase choice throughout the lease, as was shown in the basic itself.


Because case the interest rate needed to amortize the loan is imputed through an experimentation method by also considering the bring value of the asset as discussed above, rather than by calculating it based entirely on the elements associated with the liability.


In result the existence of the purchase alternative is treated by the lessee as if it will be exercised and the lease liability is amortized to that point. If the condition triggering the stopped working sale-leaseback no longer exists, for example the purchase choice is not worked out, then the carrying quantities of the liability and the hidden possession are gotten used to then use the sale treatment and any gain or loss would be recognized.


The FASB example is as follows:


842-40-55-31 - An entity (Seller) offers a property to an unassociated entity (Buyer) for cash of $2 million. Immediately before the transaction, the asset has a carrying quantity of $1.8 million and has a remaining beneficial life of 21 years. At the very same time, Seller participates in an agreement with Buyer for the right to use the property for 8 years with yearly payments of $200,000 payable at the end of each year and no renewal options. Seller's incremental loaning rate at the date of the transaction is 4 percent. The agreement consists of an option to repurchase the possession at the end of Year 5 for $800,000."


Authors comment: A basic computation would conclude that this is not a "market-based transaction" since the seller/lessee could just pay 5-years of rent for $1,000,000 and then purchase the possession back for $800,000; not a bad deal when they offered it for $2 million. Nonetheless this was the example supplied and the leasing industry determined that the rate needed to fulfill the FASB's test was determined utilizing the following table and an experimentation method.


In this example the lessee should utilize a rate of approximately 4.23% to come to the amortization such that the financial liability was never less than the asset net book worth as much as the purchase alternative workout date.


Since the entry to record the unsuccessful sale and leaseback involves establishing an amortizing liability, at some time a repaired price purchase alternative in the contract (which caused the unsuccessful sale and leaseback in the very first place) would be


If we assume the purchase alternative is exercised at the end of the fifth year, at that time the gain on sale of $572,077 would be acknowledged by eliminating the staying lease liability of $1,372,077 with the exercise of the purchase choice and payment of the $800,000. The previously tape-recorded ROU property would be reclassified as a fixed asset and continue to be depreciated throughout its remaining life.


If on the other hand the purchase alternative is NOT exercised (presuming the transaction was more market based, for example, assume the purchase alternative was $1.2 million) and basically expires, then presumably the remaining lease liability would be changed to reflect the present value of the staying rents yet to be paid, marked down at the then incremental loaning rate of the lessee.


Any distinction between the then exceptional lease liability and the recently calculated present value would likely be an adjustment to the remaining ROU possession, and the ROU possession would then be amortized over the remaining life of the lease. Assuming today value of the 3 remaining payments utilizing a 4% discount rate is then $555,018, the following adjustments should be made to the schedule.


Any stopped working sale leaseback will need examination and analysis to totally comprehend the nature of the transaction and how one should follow and track the accounting. This will be a relatively manual effort unless a lessee software application package can track when a purchase option ends and creates an automated adjusting journal entry at that time.


Apparently for this reason, the FASB also provided for adjusted accounting for transactions previously accounted for as failed sale leasebacks. The FASB recommended when adopting the new standard to take a look at whether a transaction was formerly an unsuccessful sale leaseback.


Procedural Changes to Avoid a Failed Sale and Leaseback


While we can get immersed in the triviality of the accounting information for a failed sale-leaseback, recognize the FASB presented this somewhat cumbersome accounting to derecognize just those possessions in which the deal was clearly a sale. This procedure existed formerly just for genuine estate deals. With the introduction of ASC 842, the accounting likewise should be looked for sale-leasebacks of equipment.


If the tax guidelines or tax interpretations are not clarified or altered, numerous existing properties under lease would not be eligible for benefit depreciation merely since when the original sale leaseback was performed, the lessees managed themselves of the existing transaction guidelines in the tax code.


Moving forward, lessors and lessees must establish brand-new approaches of administratively executing a so-called sale-leaseback while thinking about the accounting issues inherent in the new standard and the tax guidelines discussed formerly.


This might require a prospective lessee to schedule one or lots of potential lessors to underwrite its brand-new leasing company beforehand to prevent getting in into any type of sale-leaseback. Naturally, this implies much work will need to be done as soon as possible and well ahead of the placement for any equipment orders. Given the asset-focused specialties of many lessors, it is unlikely that a person lessor will want to handle all forms of equipment that a potential lessee may want to rent.


The concept of a failed sale leaseback ends up being complex when thinking about how to account for the transaction. Additionally the resulting prospective tax implications might occur many years down the road. Nonetheless, since the accounting standard and tax guidelines exist as they are, lessees and lessors should either adjust their techniques or comply with the accounting requirements promulgated by ASC 842 and tax guidelines under TCJA.


In all probability, for some standardized transactions the methods will be adapted. For larger transactions such as property sale-leasebacks, imaginative minds will again take a look at the repercussions of the accounting and simply consider them in the way they enter these deals. In any occasion, it keeps our industry interesting!