With inflation at record levels and interest rates rising steadily, business owners across the country have been looking at ways to monetize their existing assets to realize much-needed capital. Doing a sale-leaseback transaction is usually much faster than getting a bank loan which is why it remains popular with business owners.
In this blog, we take a look at how sale-leaseback transactions work and their relative pros and cons:
What is a Sale-Leaseback?
In a sale-leaseback transaction, the seller sells a property to the buyer and then takes out a lease on the same property. This arrangement lets the seller continue using the facility while freeing up capital for other purposes. Once the sale goes through, the seller-tenant will have relinquished their ownership interest in the property.
However, they will be able to lease the property on preferential terms over the long term. A key advantage of a sale leaseback is that the seller can claim a deduct depreciation while the property still has useful life left.
Depending on its age, the useful life of a commercial building can be up to 39 years. If the property is at the end of its useful life, the seller would be unable to deduct any depreciation when filing taxes. In turn, this would have a negative impact on the seller’s bottom line.
What are the Advantages and Disadvantages of Sale Lease Back?
- Seller
The average duration of lease buy-back transactions is around 5 to 10 years. If rental rates increase in the meantime, the tenant (seller) can continue paying the same rental until the lease expires. Generally speaking, commercial rentals are more stable than personal rentals. Thus, a sale-leaseback transaction is ideal for the tenant (seller) in the long term.
- Buyer-landlord
Some tenants (sellers) prefer to stick with the same property because other alternatives are too expensive or located too far away. This means that the buyer (landlord) naturally has the upper hand it is time for renewal.
The problem is that if the tenant (seller) is unable to continue making payments on time, the buyer (landlord) may be forced to settle for a lower rate or terminate the lease. This is a risk that is
Disadvantages
- Seller-tenant
At the end of the lease term, the seller-tenant will no longer have an ownership interest in the property or the right to receive any appreciation in the property’s value. Additionally, a seller-tenant will be obligated to pay higher-than-fair-market rent if the commercial rental market depreciates.
In a typical sale-leaseback transaction, the seller-tenant will enter into the rental agreement for an extended period, and if the commercial rental market decreases, the seller-tenant must pay the contractual rental amount.
- Buyer-landlord
If the seller (tenant) is unable to pay and defaults, the buyer (landlord) has no choice but to either renegotiate the lease or ask them to leave and get a new tenant. In the event the seller (tenant) files for bankruptcy, the odds of the buyer (landlord) recovering the rent are slim.
Last Words
A sale leaseback allows a business to deduct rent when filing taxes. You can further do a 1031 exchange on the transaction to further decrease the tax obligation. However, for this, the lease needs to be structured correctly (NNN).
If you need assistance with an ongoing lease buyback transaction, True North can help. Our team can help you maximize your tax deductions. Contact us for more information!
