March 27

Sale-Leaseback: Should You Do It?

A sale-leaseback is frequently used by companies who wish to raise capital but either can't or don't wish to borrow. Sometimes a company wants to do a sale-leaseback to reduce their physical size but wants to remain in their present facility.

But is selling then leasing back your property really a good idea?

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Reasons for a Sale-Leaseback

I'm frequently asked, "Why would a company want to sell their property only to become a tenant and remain in that property?" which is a very logical question. Well, to the surprise of many, there are some very compelling reasons to sell and leaseback a property.

The top reason I see for commercial property owners in my market wanting to sell their property then lease it back is that they want to raise capital to expand their business without having to borrow.

Many of these business owners have businesses that may have had recent financial problems or own businesses that traditional lenders see as problematic. Consequently, those lenders will either out-right refuse to loan or they'll charge extremely high interest rates that make it very expensive for the borrower.

In either case, owners of these businesses see the sale-leaseback transaction as the best option to raise needed capital without having to incur the expense and business disruption of a physical relocation.

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Another reason why commercial property owners want to sell their property then lease it back is because they want to physically down-size their business operation while remaining in their same location. This is done in order to maintain local market presence.

This is also done when a business wants to down-size in their existing location to maintain their existing customer base and use the capital from the sale of the property to expand into a new market location.

Issues to Consider

As with any other important business decision there are issues that should be considered before proceeding with a sale-leaseback transaction.

However, in my view, the most significant of all is the issue of capital gains income taxes.

When real Estate used for business purposes is sold and the seller receives a profit, that profit is subject to federal and state capital gains income taxes (assuming the state has a capital gains tax provision).

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Profit is generally defined as the amount between the basis (the original purchase price, most expenses to close the purchase, and the cost of capital improvements made to the property) and the net received after paying sales related expenses (e.g. real estate brokerage commissions, legal fees, etc.). The rate at which the capital gain is taxed depends on the tax classification of the seller.

In transactions when the seller is going to purchase another property for their business, they can legally defer payment of their federal and state capital gains tax by employing the provision of I.R.C. §1031 commonly known as the 1031 tax deferred exchange.

However, the seller in a sale-leaseback transaction who is not going to buy another property for their business will be required to pay both federal and state capital gains taxes on the profit from the sale of their property. And, depending on the amount of the profit and the income tax bracket of the seller, the capital gains taxes could range from tens of thousands to hundreds of thousands of dollars all of which is due in the same tax year of the property sale.

Is a Typical Sale-Leaseback for You?

While some property owners may actually benefit from a typical sale-leaseback transaction, due to the financial consequences of triggering a significant capital gains tax financial liability, it's unlikely this type of a transaction will benefit most.

But, this doesn't mean a seller must sell and endure the high costs and business disruption to sell and relocate their business. That's because, depending on the specific circumstances of the property owner, there are alternatives to a "typical" sale-leaseback transaction that can accomplish the same results.

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Contact us if you'd like to learn how we can help you create a non-disruptive sale-leaseback transaction while also legally avoiding paying capital gains taxes.

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