|Sale and Leaseback
Numerous reasons exist for sale and leaseback, the process of selling personal property to a lessor and leasing it back for a period of time. These many reasons can be segmented into five important areas:
Financial reporting reasons - A lease creates rent expense. The rent expense is typically less than the sum of the book depreciation and interest expense incurred in a loan during the first half of the lease term. The lower expenses under the lease cause a corresponding increase in reported earnings. Another financial reporting reason for a lessee to consider a sale and leaseback is to boost reported earnings through recognition of the gain from the sale of the equipment to the lessor.
Financial or economic aspects - Every firm is concerned with its profitability. By entering into a leaseback, a lessee may enhance its return on assets (ROA). Reported earnings are applied to a reduced asset base. Additionally, a company may enter into a sale and leaseback to address restrictive loan covenants such as maximum debt to equity ratio and total allowable debt outstanding. Through the selective utilization of a sale and leaseback, a lessee may be in a better position to secure additional debt in the future.
Liquidity reasons - A sale and leaseback provides an immediate source of cash. This cash can be used for new investment opportunities or to refinance or consolidate old loans.
Tax reasons - A sale and leaseback creates a means for a lessee with Net Operating Loss (NOL) to offset the taxable gain on the sale of the asset. The earlier the tax benefits are used, the more value they have on a present value basis. A sale and leaseback can reverse, or at least minimize, some of today's tax problems. Using the Alternative Minimum Tax (AMT) as an example, a company can eliminate the accelerated depreciation preference item applicable to owning equipment.
Risk minimization - A company may purchase a piece of equipment that has a shorter technological life than originally anticipated. The fear of such obsolescence may prompt a company to enter into a sale and leaseback. Entering into a lease that is for a shorter period, is more in line with its actual life expectancy can help minimize the risk due to obsolescence.