Sales-Leasebacks: The Devil Is In The Details

A sale-leaseback occurs when a company sells an asset to a lessor then and rents it back. The leaseback might be for the entire asset or a portion of it (as in property) and for its entire remaining helpful life or for a shorter period.


Sale-leaseback accounting addresses whether the asset is derecognized (gotten rid of) from the seller's balance sheet, whether any revenue or loss is recognized 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 worth of the leaseback was 10% or less of the possession's reasonable market price at the time of the sale, any profit resulting from the sale might be recognized completely 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 acknowledged to the degree it exceeded today value of the leaseback, while the leaseback stayed off the balance sheet due to the fact that it was reported as an operating lease. In essence any gain that was less than or equal to the PV of the leaseback was deferred and amortized over the leaseback term. The gain would basically be acknowledged as a decrease to offset the future rental cost.


For leasebacks equivalent to or greater than 90%, the property would stay on the lessee's balance sheet, no gain could be reported and any earnings would be treated as loans to the lessee from the purchaser.


Under FAS 13 and ASC 840, sale-leasebacks of realty and equipment thought about important to realty included an added caution. If the leaseback consisted of any form of fixed cost purchase alternative for the seller/lessee, it was ruled out a sale-leaseback.


Therefore, even if the sale was a legitimate sale for legal and tax purposes, the asset remained on the lessee's balance sheet and the sale was treated as a funding or borrowing against that property. The FASB's position was based upon what was then understood as FAS 66 "Accounting for Sales of Real Estate" which highlighted the numerous special methods which realty sale transactions are structured. Additionally, the FASB kept in mind that many such genuine estate transactions led to the seller/lessee buying the asset, hence supporting their view that the sale-leaseback was merely a form of funding.


Sale-leasebacks Under ASC 842


Accounting for sale-leaseback deals under ASC 842 lines up the treatment of a property sale with ASC 606 relating to profits acknowledgment. As such, if a sale is acknowledged under ASC 606 and ASC 842, the complete revenue or loss may hence be taped by the seller-lessee.


ASC 842 is said to really enable more sale and leaseback transactions of real estate to be considered a sale under the brand-new set of requirements, offered the sale and leaseback does not include a fixed price purchase option.


On the other hand nevertheless some deals of possessions besides real estate or equipment important to genuine estate will be thought about a stopped working sale and leaseback under ASC 842. As pointed out above, those sales and leasebacks that include a repaired price purchase option will no longer be considered a 'effective' sale and leaseback.


A failed sale-leaseback occurs when


1. leaseback is categorized as a finance lease, or
2. a leaseback includes any repurchase choice and the asset is specialized (the FASB has actually shown that realty is generally thought about specialized), or
3. a leaseback consists of a repurchase option that is at other than the property's fair value determined "on the date the choice is exercised".


This last item suggests that any sale and leaseback that consists of a set rate purchase option at the end will stay on the lessee's balance sheet at its amount and classified as a set property instead of 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 possession is not gotten rid of from the lessee's balance sheet if those conditions exist!


Note also that additional subtleties too many to deal with here exist in the sale-leaseback accounting world.


The accounting treatments are discussed further listed below.


IFRS 16 Considerations


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


1. if the seller-lessee has a "substantive repurchase alternative" than no sale has occurred and
2. any gain recognition is limited to the amount of the gain that relates to the buyer-lessors residual interest in the hidden possession 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 choice is provided, aside from a purchase alternative the value of which is determined at the time of the workout. Ironically IFRS 16 now requires a limitation on the amount of the gain that can be acknowledged in a similar style to what was allowed under ASC 840, specifically the gain can just be recognized to the extent it goes beyond the present worth of the leaseback.


Federal Income Tax Considerations


In December 2017, Congress passed and the President signed what has actually become referred to as the Tax Cuts and Jobs Act (TCJA). TCJA supplied for a restoration of bonus offer depreciation for both new and pre-owned possessions being "utilized" by the owner for the very first time. This indicated that when a taxpayer initially placed an asset to utilize, they could claim benefit depreciation, which starts now at 100% for properties which are acquired after September 27, 2017 with certain limitations. Bonus devaluation will begin to phase down 20% a year starting in 2023 until it is removed and the devaluation schedules revert back to standards MACRS.


Upon the passing of TCJA, a question occurred as to whether a lessee could declare reward devaluation on a rented property if it obtained the property by working out a purchase option.


For circumstances, assume a lessee is renting a possession such as a truck or device tool or MRI. At the end of the lease or if an early buyout option exists, the lessee may work out that purchase choice to obtain the property. If the lessee can then instantly write-off the value of that possession by declaring 100% bonus offer devaluation, the after tax cost of that asset is right away lowered.


Under the present 21% federal business tax rate and following 100% bonus devaluation, that suggests the asset's after tax expense is minimized to 79% (100% - 21%). If nevertheless the asset is NOT qualified for bonus devaluation because it was formerly used, or must we state, made use of by the lessee, then the expense of the property starts at 100% minimized by the present value of the future tax reductions.


This would imply that a rented asset being acquired might result in an inherently greater after-tax expense to a lessee than an asset not rented.


Lessors were concerned if lessees could not claim bonus offer depreciation the worth of their assets would become depressed. The ELFA brought these concerns to the Treasury and the Treasury reacted with a Notification of Proposed Rulemaking referenced as REG-104397-18, clarifying that the lessee can claim benefit depreciation, offered they did not formerly have a "depreciable interest" in the property, whether devaluation had actually ever been declared by the seller/lessee. The IRS asked for remarks on this proposed rulemaking and the ELFA is responding, however, the last guidelines are not in location.


In numerous renting transactions, seller/lessees build up a number of similar possessions over a period of time and then get in into a sale and leaseback. The present tax law allowed the buyer/lessor to treat those properties as new and thus under prior law, gotten approved for benefit depreciation. The arrangement followed was frequently known as the "3 month" whereby as long as the sale and leaseback occurred within 3 months of the property being placed in service, the buy/lessor could likewise claim bonus offer depreciation.


With the arrival of bonus offer depreciation for utilized possessions, this guideline was not needed considering that a buyer/lessor can declare the perk devaluation no matter how long the seller/lessee had actually previously utilized the possession. Also under tax guidelines, if a property is gotten and after that resold within the exact same tax year, the taxpayer is not entitled to claim any tax depreciation on the asset.


The intro of the depreciable interest concept tosses a curve into the analysis. Although a seller/lessee may have owned an asset before entering into a sale-leaseback and did not claim tax depreciation because of the sale-leaseback, they likely had a depreciable interest in the possession. Many syndicated leasing transactions, particularly of automobile, followed this syndication approach; many properties would be collected to attain an important dollar worth to be sold and rented back.


Since this writing, all assets come from under those situations would likely be ineligible for benefit depreciation ought to the lessee exercise a purchase alternative!


Accounting for a Failed Sale and Leaseback by the lessee


If the transfer of the asset is ruled out a sale, then the asset is not derecognized and the profits received are treated as a financing. The accounting for a failed sale and leaseback would be different depending upon whether the leaseback was identified to be a finance 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 the capitalized worth of the leaseback, depending upon which of those methods developed a higher asset and balancing out lease liability.


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


Two caveats exist regarding how the financing portion of the stopped working sale-leaseback should be amortized:


No negative amortization is allowed Essentially the interest expenditure recognized can not go beyond the of the payments attributable to principal on the lease liability over the shorter of the lease term or the funding term.
No built-in loss might result. The carrying value of the hidden asset can not surpass the financing commitment at the earlier of the end of the lease term or the date on which control of the underlying asset transfers to the lessee as purchaser.


These conditions may exist when the stopped working sale-leaseback was triggered for example by the existence of a repaired cost purchase option during the lease, as was highlighted in the standard itself.


In that case the rates of interest required to amortize the loan is imputed through an experimentation approach by also thinking about the bring worth of the possession as gone over above, instead of by determining it based exclusively on the factors related to the liability.


In impact the existence of the purchase alternative is treated by the lessee as if it will be worked out and the lease liability is amortized to that point. If the condition triggering the stopped working sale-leaseback no longer exists, for circumstances the purchase option is not exercised, then the bring amounts of the liability and the hidden asset are adapted to then use the sale treatment and any gain or loss would be acknowledged.


The FASB example is as follows:


842-40-55-31 - An entity (Seller) sells an asset to an unrelated entity (Buyer) for money of $2 million. Immediately before the deal, the asset has a carrying amount of $1.8 million and has a remaining helpful life of 21 years. At the very same time, Seller participates in a contract with Buyer for the right to utilize 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 interest rate at the date of the deal is 4 percent. The agreement includes a choice to redeem the possession at the end of Year 5 for $800,000."


Authors comment: A basic calculation would conclude that this is not a "market-based transaction" given that the seller/lessee might simply pay 5-years of rent for $1,000,000 and then purchase the property back for $800,000; not a bad offer when they sold it for $2 million. Nonetheless this was the example offered and the leasing market determined that the rate required to satisfy the FASB's test was figured out utilizing the following table and a trial and mistake technique.


In this example the lessee need to use a rate of roughly 4.23% to get to the amortization such that the monetary liability was never less than the asset net book value up to the purchase option exercise date.


Since the entry to tape-record the unsuccessful sale and leaseback includes developing an amortizing liability, at some time a fixed cost purchase option in the arrangement (which caused the unsuccessful sale and leaseback in the very first location) would be


If we presume the purchase option 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 remaining lease liability of $1,372,077 with the workout of the purchase option and payment of the $800,000. The previously recorded ROU property would be reclassified as a set asset and continue to be depreciated during its remaining life.


If on the other hand the purchase alternative is NOT exercised (assuming the transaction was more market based, for example, assume the purchase choice was $1.2 million) and essentially ends, then probably the remaining lease liability would be adapted to show the present value of the staying rents yet to be paid, marked down at the then incremental interest rate of the lessee.


Any distinction in between the then exceptional lease liability and the freshly computed present value would likely be an adjustment to the staying ROU asset, and the ROU property would then be amortized over the remaining life of the lease. Assuming the present value of the 3 staying payments utilizing a 4% discount rate is then $555,018, the following modifications must be made to the schedule.


Any failed sale leaseback will require scrutiny and analysis to completely comprehend the nature of the transaction and how one should follow and track the accounting. This will be a fairly manual effort unless a lessee software plan can track when a purchase alternative ends and produces an automated adjusting journal entry at that time.


Apparently for this factor, the FASB likewise attended to adjusted accounting for deals formerly accounted for as failed sale leasebacks. The FASB suggested when embracing the new standard to analyze whether a transaction was formerly a failed sale leaseback.


Procedural Changes to Avoid a Failed Sale and Leaseback


While we can get absorbed in the triviality of the accounting information for a stopped working sale-leaseback, recognize the FASB presented this rather cumbersome accounting to derecognize only those possessions in which the transaction was plainly a sale. This process existed formerly only genuine estate deals. With the advent of ASC 842, the accounting also needs to be looked for sale-leasebacks of equipment.


If the tax rules or tax analyses are not clarified or changed, lots of existing possessions under lease would not be qualified for perk devaluation merely because when the initial sale leaseback was carried out, the lessees afforded themselves of the existing transaction rules in the tax code.


Moving forward, lessors and lessees must develop new techniques of administratively executing a so-called sale-leaseback while thinking about the accounting concerns intrinsic in the brand-new standard and the tax rules gone over formerly.


This may need a prospective lessee to organize for one or many potential lessors to underwrite its new leasing company beforehand to avoid entering into any form of sale-leaseback. Naturally, this implies much work will need to be done as quickly as possible and well ahead of the positioning for any equipment orders. Given the asset-focused specializeds of lots of lessors, it is not likely that one lessor will prefer to deal with all forms of devices that a prospective lessee might want to lease.


The concept of a failed sale leaseback ends up being complex when considering how to represent the deal. Additionally the resulting possible tax ramifications may arise numerous years down the roadway. Nonetheless, considering that the accounting requirement and tax guidelines exist as they are, lessees and lessors should either adjust their methods or conform to the accounting requirements promoted by ASC 842 and tax guidelines under TCJA.


In all likelihood, for some standardized transactions the methods will be adapted. For larger deals such as property sale-leasebacks, imaginative minds will once again analyze the effects of the accounting and simply consider them in the method they get in these transactions. In any occasion, it keeps our market intriguing!