Tax and accounting implications of leasing are usually an
after-thought of a transaction. Particularly if a company is not publicly
traded, accounting concerns are typically not considered during the real
estate occupancy process. Regardless of the company's status, it could be
valuable to you to review your current lease situation and plans with regard
to new leasing transactions with your tax and accounting advisors before
beginning the real estate occupancy process and certainly before making
major decisions regarding leasing.
Income Tax Implications
Tax implications of both an existing lease and a proposed lease may not
drive a transaction, but they can have an important impact on a company's
tax situation. In the schedule below, we have reviewed the potential
impact of various lease concessions from the tenant's and the landlord's
||The tenant will have less of an expense deduction during
||The landlord would just report less income, in most
|Cash allowance for work
||The tenant will have to record income in the period that
the cash allowance is received, or accrued. (It will depend on the
tenant's accounting method - cash or accrual). The tenant would also
depreciate the improvements constructed over a 39 year term. FF&E, which
is sometimes paid from cash allowances, would be depreciated over 7
years. The tenant would write-off any undepreciated balance at the end
of the lease or earlier termination.
||The landlord will amortize the cash allowance pro-rata
over the term of the lease.
|Landlord builds improvements for a tenant and the
landlord owns the improvements.
||The tenant would have no tax impact unless it also
contributes to the improvements. If the tenant does contribute to the
improvements, then it would depreciate the amount contributed over a
period of up to 39 years for real property items. If the lease is for
less than 39 years then the tenant would write off any undepreciated
balance at the end of the lease term or earlier termination of the lease
or vacation of the premises.
||The landlord will depreciate the improvement cost over a
39 year depreciation period. If the tenant leaves early or before 39
years, the landlord has to write-off the improvements when demolished.
If another tenant leases the space "as is", then the landlord would just
continue depreciating the improvements.
|Landlord builds improvements but shifts ownership of the
improvements to the tenant.
||The tenant would have current income to the extent of
the cost of the improvements and would have to depreciate the
improvements over a period of up to 39 years.
||The landlord would amortize the cost of the improvements
pro-rata over the term of the lease.
|Landlord reimburses a tenant's moving costs or
professional fees (Rare occurrence in Manhattan)
||The tenant would record income to the extent costs were
reimbursed but would have a corresponding deduction for the expenses
paid. (If a company is a cash basis payer, it should ensure that the
related costs are paid before year-end.)
||The landlord would amortize these costs pro-rata over
the term of the lease.
Accounting Implications For Public Companies
Typically the most critical issue from the accounting side of a real estate lease
is whether or not the lease is an operating or a capital lease.
Publicly-traded companies generally prefer not to capitalize leases so as
not to have them recorded on their balance sheet. For public companies,
Financial Accounting Standards Board 13 ("FASB 13") explains the
requirements for properly reflecting leases in the financial statements of publicly
traded companies. FASB 13 has four criteria for determining whether a lease
should be an operating or capitalized lease. If any of the four criteria are met, then the lease
obligation must be capitalized on the company's balance sheet.
The criteria are:
- By the end of the lease term, ownership of the leased property is
transferred to the lessee.
- The lease term contains a bargain purchase option.
- The lease term is substantially (75% or more) equal to the estimated
remaining useful life of the leased property.
- At the inception of the lease, the present value ("PV") of the minimum lease
payments, with certain adjustments, is 90% or more of the fair value of the
Since capitalization of a lease requires
that a company record the lease essentially like a purchase, the company's
balance sheet would reflect an asset for the property and a liability for
debt amount. The amount of the debt is synthetic and it is calculated
based on methods described in FASB 13 and other derivative standards and
The Securities And Exchange Commission
("SEC") Issued A Letter In February 2005 to Further Clarify Lease Accounting
Requirements For Public Companies
The letter focused on two areas: (i)
Leasehold improvements, whether paid for by the landlord or the tenant, but
in either case are executed by the tenant, must be amortized on the tenant's financial
statements over the shorter of the economic life of the improvements or the
lease term; (ii) Free rent periods should be amortized
over the lease term on a straight-line basis. From the landlord
perspective, incentives should be recorded as deferred rent and amortized
against lease expense as opposed to against leasehold improvements. The tenant should reflect cash incentives received from the
Landlord as an operating activity and the expenditure of funds for leasehold
improvements should be recorded as an investing activity.
several other sophisticated lease and acquisition structures, including
synthetic leases and swaps. These structures offer either accounting or tax
advantages that are beneficial to the appearance of the company's financial
For small, private companies operating on a cash basis, accounting
implications are typically not relevant and the real issue is plain old cash flow
- meeting the monthly rent obligation. TenantWise's founders have had
extensive experience in structuring larger and more complex transactions as
well as ones for smaller, private companies.
Please contact your TenantWise representative for further assistance.
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