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What Is a Sale-Leaseback?

A sale-leaseback is a financing arrangement, where one party sells property it owns to a second party, and then leases the property back from the second party under a lease agreement. In general, a sale-leaseback allows a company to raise cash, relieve itself of the responsibility of real estate or property ownership, and continue to use the property in the course of normal business operations. In terms of funding your buy-sell agreement, a sale-leaseback can provide cash for the business to use in redeeming the stock of a withdrawing shareholder. This discussion will focus on the use of the sale-leaseback for buy-sell funding.

When Can It Be Used?

Company Owns a Substantial Physical Asset It Uses For Business

If your company owns physical assets that it is currently using in the course of business operations, it can sell the property to an investor under a sale-leaseback arrangement. Then the company enters into an agreement with the new property owner to lease the asset, usually for a long term (10 to 20 years, depending upon the asset) with renewal options. The asset should have a large enough fair market value to generate a sizable amount of cash for the company.

What Types of Property Can Be Used With The Sale-Leaseback?

The types of property that are appropriate for a sale-leaseback transaction are those that are used in your trade, business, or profession and include:

Asset Category

Example

  • Buildings
  • Office building
  • Medical facility
  • Manufacturing plant
  • Retail outlet
  • Land
  • Auto sales lot
  • Ski area
  • Heavy equipment and machinery
  • Construction equipment
  • Trucks
  • Manufacturing machinery

Why Would You Want a Sale-Leaseback for Your Buy-Sell Agreement?

Many of the reasons for a sale-leaseback benefit the company, rather than you directly, so you might be asking, "Why should I care?" Remember, however, that you might be around to see the company buying back the stock of your co-owner, or your business might be a family corporation.

Transaction Can Be Done Quickly--You (or Your Estate) Can Redeem Your Stock

Sale-leaseback transactions have become more common and, with some investors, even routine. There shouldn't be a lot of lead time needed to get the transaction going, so you or your estate should not have to wait too long to get the cash for your stock.

Caution: Of course, economic conditions could limit the availability of investor funds, making the transaction more difficult to accomplish.

Sale-Leaseback Can Provide More Cash Than a Mortgage

A sale-leaseback transaction can produce a larger amount of cash than traditional mortgage financing. When you finance with a mortgage, the lender will loan you only a percentage of the value of the asset. Under a sale-leaseback, the buyer pays you the fair market value for the property. This increases your chances of receiving full payment for your stock, without having to accept installment payments.

Timing may also be an issue if the sale-leaseback is entered into after the triggering event under the buy-sell agreement. If entered into simultaneously with the buy-sell agreement, there are issues with respect to best use of the funds by the business (if the business is the purchaser). Also there is no guarantee that the funds will be there upon the proposed sale of the shares.

Provides Company With Tax-Deductible Way to Fund Stock Redemption

Generally, when a company buys back stock from a shareholder, the payments are not deductible. Under a sale-leaseback, your company pays for your stock using the cash from the transaction. The new rental payments on the asset sold are a business expense and are deductible to the company. If the company had just mortgaged the property, only the interest on the mortgage would be deductible.

Caution: The company loses the depreciation expense for the asset sold, so a full analysis of the tax impact should be undertaken first.

Avoids Surplus Funds and Capital Requirement Issues

In all states, corporate law allows a corporation to buy its own shares only from surplus funds. The specifics of the laws vary by state, but generally the rule is that a corporation must have funds in excess of the minimum capital requirement to redeem stock.

Tax law makes it difficult for companies to accumulate excess funds because of the accumulated earnings tax. A sale-leaseback transaction to fund your entity purchase agreement can provide the company with cash it may not otherwise have been able to accumulate or distribute without penalty.

Company Relieved of Property Management Responsibility

When your company sells an asset under the sale-leaseback arrangement, it may be relieved of the duties of property maintenance and management on the asset, depending on terms of the lease. The company can focus more attention on its core business.

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How Does The Sale-Leaseback Work In Your Buy-Sell Agreement?

Find an Investor

There are generally a couple of different classes of investors who engage in sale-leaseback transactions. The size of the stock redemption under your buy-sell agreement could direct the company toward one asset or another for the sale-leaseback. The size of your sale-leaseback transaction will probably direct your company toward one investor group or another.

Investor Class

General Areas of Interest

Institutional

  • Insurance companies
  • Fund sponsors
  • Corporations
  • Banks
  • Portfolios
  • Large individual properties
  • Retail outlets
  • Leasing companies
  • Equipment

Private

  • Irrevocable trust
  • Individual with cash
  • Colleges and schools
  • Smaller properties
  • Individual operations
  • Equipment

Company Sells Property to Investor (or Trust) and Receives Money to Buy Back Your Stock

Once the company has found a buyer for the company asset or set up a trust to buy the asset, the asset is sold and the cash collected. Some or all of the cash received by the company is used to buy back stock from you or your estate.

Caution: The company may have to recognize a gain on the sale of the asset.

Caution: The sale-leaseback transaction must be carefully structured to avoid adverse tax consequences. Consult your accountant or tax advisor.

Company Leases Property Back Under Lease Agreement

At the same time the business sells the asset, it enters into a lease agreement with the buyer. Lease agreements under a sale-leaseback are generally for long periods of time and often contain a renewal option. The agreement may also contain an option to repurchase the asset at the end of the lease term.

Deduct Lease Payments on Company Tax Return

The lease payments to the new owner of the asset are deductible to your company as a business expense.

Tip: Recapture and capital gains from the sale might be offset by the deduction for the lease payments.

Caution: The sale-leaseback transaction must be carefully structured or the IRS might try to disallow your company's deduction. Consult your accountant or tax advisor.

What Is The Downside?

Company Gives Up Flexibility

Once the asset is sold, the company may lose the flexibility to remodel, expand, or replace the property, depending on the terms of the lease. If the property becomes unsuitable for the business, there could be expensive consequences to breaking the lease contract.

Sale-Leaseback Transactions Between Related Parties Closely Scrutinized By The IRS

Sale-leaseback transactions between related parties tend to be closely examined by the IRS (like any other related party transaction). Related parties would include spouses, parent-child, corporation and major shareholder, or an individual trustee who is a relative.

Tip: If your sale-leaseback will involve a party related to you, carefully document the transaction. Be prepared to show that the deal was done for a valid business reason, and not just to shift income and avoid tax.

Tip: If the sale-leaseback is with your relative or family corporation, consider using an independent trustee, such as a bank or trust company.

What Do You Need to Do?

Include Sale-Leaseback as a Funding Option Within Buy-Sell Agreement

If you think you want to use a sale-leaseback to fund your buy-sell agreement, or you would want the option to choose it in the future, include it as a funding option in the terms of your buy-sell agreement.

Consult Your Tax Attorney or Accountant

There are specific criteria and accounting requirements for sale-leaseback transactions. If your transaction does not meet certain characteristics, the rental deductions will not be allowed, and the payments could be classified by the IRS as repayment of debt financing (principal and interest).

 

 

This material was prepared by Broadridge Investor Communication Solutions, Inc., and does not necessarily represent the views of  The Retirement Group or FSC Financial Corp. This information should not be construed as investment advice. Neither the named Representatives nor Broker/Dealer gives tax or legal advice. All information is believed to be from reliable sources; however, we make no representation as to its completeness or accuracy. The publisher is not engaged in rendering legal, accounting or other professional services. If other expert assistance is needed, the reader is advised to engage the services of a competent professional. Please consult your Financial Advisor for further information or call 800-900-5867.

 

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The Retirement Group is a Registered Investment Advisor not affiliated with FSC Securities and may be reached at www.theretirementgroup.com.

 


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