Equipment Sale Leaseback

A Sale Leaseback is a lease where the equipment is purchased from the Lessee instead of an equipment vendor. The Lessee retains the use of the equipment after the sale, but surrenders legal title and ownership to the Lessor. An appraisal of the equipment is necessary to show the Lessor is acquiring the asset(s) at its then Fair Market Value to avoid possible “fraudulent conveyance claims” from other creditors.

When the Asset is sold to the Lessor it must be free of liens. The Lessor must check for liens recorded on financing statements (UCC-1) in the State where the Lessee has registered his Charter papers. The Lessor should also require from the Lessee their proof of purchase from the original vendor to establish their clear ownership of the asset(s).

To complete the sale, it is recommended that the Lessor take possession of the asset(s) along with a “Bill of Sale”. If no possession is registered, a disgruntled creditor may argue that “no possession, no sale” because the equipment never left the customer’s facilities. Most states require possession to complete the sale.

The Lessee will have an accounting adjustment and an income tax consequence from a Sale Leaseback. In other words, because the IRS allows the Lessee to deduct the depreciation of an asset from the Lessee’s ordinary income, the Lessee has to report any gain from the sale of the asset(s) as ordinary income, not as a capital gain. Any gain over the original purchase price will be taxed as a capital gain.

The after tax cash result from the sale will improve the cash and the net worth positions on the Lessee’s Balance Sheet. In addition, the present value of the lease stream from a Sale Leaseback will be placed on the Balance Sheet as a leased asset and a lease liability.

A Sale Leaseback usually occurs for two reasons: First, the Lessee is an acceptable credit, but may be suffering from a bad economic year and needs to increase profits. The Sale Leaseback of assets that have a value greater than the book value will create a gain and may increase profits from negative earnings to positive earnings.

Second, a Lessee may want to sell or merge with a company that could increase its capabilities. The merger price may fail to recognize the true value of the depreciated asset(s). A Sale Leaseback brings the value of the asset(s) back on the books in the form of cash.

Finally, a Lessor should be concerned if the only reason the Lessee wants to do a Sale Leaseback is to raise cash. A cash strapped Lessee may be on the verge of bankruptcy. Needless to say, a bankruptcy filing would make it very difficult for a Lessor to recoup its investment.