Sale and leaseback of real property.Opportunity for tax and financial benefits. The IRS An abbreviation for the Internal Revenue Service, a federal agency charged with the responsibility of administering and enforcing internal revenue laws. carefully scrutinizes transactions between closely held corporations Noun 1. closely held corporation - stock is publicly traded but most is held by a few shareholders who have no plans to sell corp, corporation - a business firm whose articles of incorporation have been approved in some state and their controlling shareholders to make sure such transactions benefit the corporations, not simply the shareholders. One strategy that could provide tax and financial advantages to both a corporation and its controlling shareholder is a sale and leaseback sale and leaseback The sale of a fixed asset that is then leased by the former owner from the new owner. A sale and leaseback permits a firm to withdraw its equity in an asset without giving up use of the asset. Also called leaseback. of real property in which the corporation sells real estate with a building on it to the shareholder, who, in turn, leases both back to the company. TAX ISSUES The corporation's rental deduction deduction, in logic, form of inference such that the conclusion must be true if the premises are true. For example, if we know that all men have two legs and that John is a man, it is then logical to deduce that John has two legs. vs. its depreciation deduction. If the real property has been in service for many years, a sale and leaseback could generate a much larger rental expense deduction for the corporation than its current depreciation deduction. In the latter situation, the corporation would depreciate depreciate v. in accounting, to reduce the value of an asset each year theoretically on the basis that the assets (such as equipment, vehicles or structures) will eventually become obsolete, worn out and of little value. (See: depreciation) only the building (not the land) and the amount of the depreciation would be based on its original cost. In a sale and leaseback, the rent paid by the corporation typically is based on the fair market value of both the land and the building, and the deduction,, therefore, is usually larger. Shareholder's depreciation. After a sale and leaseback, the shareholder's basis in the property will be its fair market value, which usually is higher than the price the corporation originally paid (if the land and building have gone up in value). Thus, the shareholder's depreciation deduction on the building may be substantially higher than that previously available to the corporation. Rental income Noun 1. rental income - income received from rental properties income - the financial gain (earned or unearned) accruing over a given period of time as passive income. A sale and leaseback may enable the shareholder to generate passive rental income to offset passive losses he or she may have. However, whether the shareholder may characterize the rental income as passive depends on both his or her ownership interest in the corporation and material participation in its business. VALIDITY OF THE SALE AND LEASEBACK To take advantage of the benefits of a sale and a leaseback A transaction whereby land is sold and subsequently rented by the seller from the purchaser who is the new owner. , both must be valid. No one factor controls; the overall facts and circumstances CIRCUMSTANCES, evidence. The particulars which accompany a fact. 2. The facts proved are either possible or impossible, ordinary and probable, or extraordinary and improbable, recent or ancient; they may have happened near us, or afar off; they are public or surrounding the transactions determine their validity. Ultimately, the determination will center on whether the transactions have economic substance and have been based on reasonable market conditions. Sale. For the sale to be valid, the controlling shareholder must have taken an equity interest in the property and assumed the risk of loss. An equity interest exists if the funds for the purchase of the property came from the shareholder or if he or she borrowed money to make the purchase. The shareholder's purchase of an insurance policy on the property would show assumption of the risk of loss. Leaseback. For a leaseback, to be valid, four tests must be met: * The useful life of the leased property must exceed the term of the lease. * If the corporation repurchases the property at the end of the lease, it must do so at fair market value and not at a discount. * If the transaction allows for a renewal at the end of the original lease term, the renewal rate must be set at a fair rental value rental value n. the amount which would be paid for rental of similar property in the same condition in the same area. Evidence of rental value becomes important in lawsuits in which loss of use of real property or equipment is an issue, and the rental value is the . * The shareholder must have a reasonable expectation that he or she will generate a profit from the sale and leaseback, considering both the value of the property when it is eventually sold and the rent received during the lease term. For a detailed discussion of these transactions, see "Sale-and-Leaseback of Real Property," by Philip Fink fink Slang n. 1. A contemptible person. 2. An informer. 3. A hired strikebreaker. intr.v. finked, fink·ing, finks 1. To inform against another person. , in the May 2001 issue of The Tax Adviser. |
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