How to Take Advantage of a Sale-Leaseback

Property tax by Nick Youngson CC BY-SA 3.0 Pix4free

Trying to free up some of your real estate capital, but your best option for this is a property you own?.

There’s a simple solution: the sale-leaseback. If you have a real estate investor in mind that is willing to enter into this agreement for you, even better. By selling your property to an investor and then entering into an agreement to continue to occupy the property and enter into a lease agreement. This mutually-beneficial agreement gives the investor a built-in lessee without having to go through the hassle of showing the property and vetting potential occupants, while also allowing the current owner to reduce their debt or free up balance sheet capital to invest in their own business expansion.

This type of real estate transaction has flourished during the pandemic, allowing business owners to continue to occupy their current space, lock in their rent long-term, while also freeing up some of their debt to help with business costs. By liquidating some of the business assets, it allows the owners additional flexibility with what they need to do with those funds. Plus, it serves as a terrific alternative to conventional financing or refinancing options, especially at a time when cash on hand is paramount for the business owner.

In this transaction, the seller and purchaser need to work together to make a mutually-beneficial situation for both parties. The property should be sold to as close to market value as possibly, while also locking in the lessee to a rental price at the same price or less than market value. This situation limits the risk for both.

Seller Advantages

There are many pros for the seller in this type of agreement, including the ability to keep your current workspace option. You can improve your credit rating with this transaction, while also avoiding any debt restrictions caused by previous loan agreements.

Cost recovery can happen through depreciation and any interest payments made are tax deductible. (Just remember the time limits that exist on depreciation of commercial real estate.) The now lessee can also now deduct their rent payments on taxes. 

Buyer Advantages

The buyer, in addition to already having a built-in tenant for their new real estate property, can find that this arrangement has a higher rate of return for them than traditional loan returns, and is usually more predictable due to the setup. Plus, any reversionary interest accrued belongs to the buyer.

Other Considerations

Sale-leaseback options also qualify for capital gain-ordinary loss as outlined in Section 1231, which primarily benefits the seller in most cases. Consulting with a qualified tax professional regarding any risks to the recognition of potential tax breaks is vital prior to entering into a sale-leaseback agreement. The buyer may also benefit from tax deductions, including mortgage interest and other tax credits.

In the “cons” column for both buyer and seller, there are items. As the seller no longer owns the property, they have lost the flexibility to do exactly what they want with the property. Plus, their new rent and financing terms are locked in at time of sale, and are not subject to any market fluctuation. The seller may default on their lease, making it difficult for the buyer to find a new tenant for the space. The buyer also will have to bear administrative costs associated with being a landlord and operating the commercial property.

How do you know if the sale-leaseback is the best option for you? If you find yourself needing some liquidity in your business assets but have limited financing options, consider the sale-leaseback as part of your strategy to expand your business.

As a Qualified Intermediary, Preferred 1031, is prohibited from providing tax or legal advice.  

Taxpayer must seek such counsel from their advisors. For more information on 1031 Exchanges, please set up a free consultation with one of our advisors by contacting us at:

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