Sale-Leaseback Agreements Offer a Way to Raise Cash
For contractors with equipment who need cash, sale-leaseback agreements can be valuable. Guajardo discusses some options.
|Leslie V. Guajardo, CPA, CCIFP, is a partner at Padgett, Stratemann & Co. LLP in San Antonio. She can be reached at 210-253-1530 or Leslie.Guajardo@padgett-cpa.com
Most businesses struggle with a shortage of cash at some point. For contractors it’s nearly a way of life.
What some contractors overlook is a way to raise cash other industries don’t have. This is provided by equipment through sale-leaseback agreements.
Sale-leaseback agreements essentially work this way: A contractor sells its equipment to a finance company and leases it back. The contractor raises capital while retaining use of the equipment.
For tax purposes, FASB Statement 13 generally treats a sale-leaseback as a single transaction in which any profit or loss is deferred and amortized by the seller, who becomes the lessee. The statement requires the seller to recognize some profit or loss in either of the limited circumstances: If the seller retains the use of only a minor part of the property, the sale and lease would be accounted for based on their separate terms.
If the rentals called for by the lease are unreasonable in relation to current market conditions, an appropriate amount would be deferred or accrued by adjusting the profit or loss on the sale. The amount deferred or accrued would be amortized as an adjustment of those results. If the seller retains more than a minor part but less than substantially all of the use of the property via the leaseback, and the profit on the sale exceeds the present value of the minimum lease payments or the recorded amount of the leased asset for a capital lease, that excess would be recognized as profit at the date of the sale.
Common leaseback agreements are:
Fair Market Value Lease (True Lease): The lessee (contractor) has the option to purchase the leased equipment at the end of the lease term for the fair market value or the equipment can be returned. Monthly payments are fixed and usually tax deductible.
10% Purchase Option: The lessee can purchase the equipment at the end of the lease term for 10% of the original fair market value or purchase price.
$1 Buyout: The lessee repays the lease obligation with a fixed monthly payment and takes ownership of the equipment at the end of the lease with a dollar buyout.
Equipment Finance Agreement: Is basically a loan against the equipment that offers a fixed monthly payment not linked to the prime rate. The contractor will own the equipment and the investor will release the security interest at the end of the lease. There usually are no blanket liens or compensating balances, which banks often require.
Terminal Rental Adjustment Clause Lease: A tax-oriented lease of titled vehicles or trailers that contain the fixed purchase amount and complies with True Lease requirements set forth by IRS rules. TRAC leases are used for financing transactions containing only titled equipment and with residuals from 10 to 20%.
In the beginning, the finance company or purchaser will require the contractor show receipts and invoices related to the original purchase. Once the fair market value of the equipment has been established, the contractor sells the equipment for up to 70% of the value and enters into a lease agreement. If the contractor purchased the equipment new within the past 90 days, funding can be up to 100% of the original invoice.
Leaseback agreements have drawbacks as well. Contractors who lease equipment can not make modifications to the property. Re-assuming ownership of the equipment is only possible if a repurchase option is included in the agreement. In this case, the lease will likely be categorized as a capital lease, meaning the seller assumes some risk of ownership and benefits such as the ability to claim depreciation.
A lease is considered a capital lease if any of the following factors exists: 1) The term of the lease exceeds 75% of the equipment’s life; 2) There is a transfer of ownership at the end of the lease; 3) There is an option to purchase the asset at a discount once the lease expires; 4) The present value of the minimum lease payment is greater than 90% of the equipment’s fair market value.
Sale-leaseback agreements can be a valuable tool. The tricky part is whether to include a repurchase option. Consult an accountant.