Sale-Leaseback Transactions in the 'Corporate Scandal' Era

An SLT, however, is almost always more complicated to close than a conventional mortgage. Such is the case because: 1) restrictions imposed by the SLT lessor on use of the underlying property by the SLT-seller/lessee are often more onerous than with conventional financing; 2) there are always more parties at the table; and 3) the accounting requirements are significantly more restrictive, often flying in the face of real estate as well as economic realities, thereby giving the business parties much pause. As a result, most SLTs are entered into by sellers who are primarily motivated by a desire to enhance their balance sheet. Hence, they are more willing to endure burdensome lease restrictions and work through a more complicated transaction. See Jeffrey H. Newman and Mark S. Levenson, Sale-Leaseback Transactions after Enron and Worldcom ' A Tougher Landscape, New Jersey Business, October 2002.

Business Concerns

Each SLT is driven by the business realities impacting the particular deal. For instance, the prospective purchaser (SLT-lessor) 1) will likely want significant restrictions on the ability of the SLT-seller/lessee to transfer the property during the lease period, unless a credit guarantee remains in place; 2) may want approval rights regarding transfers; 3) might insist on higher standards of maintenance and/or an enhanced capital replacement program (thereby creating negative impact on the deal economics); 4) may want input or perhaps even veto rights with respect to any significant management issues relating to the property; and 5) could have conflicting views on the development of adjacent property if owned or becomes owned by the SLT-seller/ lessee. Although the overall economics of the SLT (ie, the sale price in relation to the lease carry costs) may make all of the foregoing of minor concern to the SLT-seller/lessee, these issues, nonetheless, must be worked through and reconciled. While having a “rated” guarantor of the SLT-seller/lessee or a “rated” SLT-seller/lessee lessens the concerns of the purchaser/lessor on the foregoing issues, because the purchaser/lessor could then look primarily to the creditworthiness of the guarantor or SLT-seller/lessee, as opposed to the real property collateral, significant negotiation on these issues is still likely.

Another area of concern that often complicates an SLT is environmental. Even with the credit of a strong guarantee, a lender funding the SLT will require a comprehensive environmental review. The environmental review, depending on the lender's requirements and whether there may be a future securitization, can be more rigorous and may therefore necessitate enhanced environmental remediation or the implementation of additional environmental compliance and maintenance programs beyond that which might have been required in a conventional mortgage. Thus, notwithstanding scope and quality, creditworthiness by itself may not be enough to vitiate the higher environmental standards that may be required by a lender.

Accounting Treatment

As noted above, the structure of an SLT is often dictated by the accounting requirements necessary to obtain “operating lease” characterization. What may be agreed to in a term sheet between a motivated SLT-seller/lessee and SLT-purchaser/lessor may not survive the required accounting hurdles. Post-Enron, accounting firms are even more conservative in their approach to granting “operating lease” status to the leaseback portion of SLTs. The major accounting firms, in particular, will often hew to the black and white of the accounting industry guidelines and their manuals and are unwilling to go into the gray. SLTs are further complicated by the fact that the Financial Accounting Standards Board (“FASB”) financial accounting criteria are not identical to published Internal Revenue Service (“IRS”) guidance. FASB provides more bright-line tests that are, therefore, safer to work with than the IRS' safe harbors, which are not bright line and even less consistently market realistic. (On account of the sometimes non-identical treatment, some transactions are structured to take advantage of these differences to obtain the benefit of inconsistent book and tax treatment, ie, an “operating lease” for book purposes and “a financing” for tax purposes, to avoid a gain on any appreciation. Holthouse, 593 Tax Management (BNA), Real Estate Leases, Section VI, SLTs at A-49 through A-56(1) (“Holthouse”)). Reconciling these potentially conflicting FASB and IRS guidelines requires creativity, patience and special effort to achieve the parties' respective goals and yet remain in respective compliance.

To accomplish this, as well as “operating lease” treatment, the accounting requirements applicable to the proposed transaction should be ascertained in light of the SLT-seller/lessee's specific objectives at the early stages of the transaction. In so doing, before unnecessary time and cost is expended, the parties can determine their ability to 1) meet the applicable accounting requirements; and 2) adjust the proposed transaction in order to satisfy the accounting requirements in a manner that will not interfere with the attainment of the SLT-seller/lessee's financial goals from the proposed SLT.

While this article should not be construed as providing accounting or tax advice, it is appropriate to highlight some of the major accounting issues in a proposed SLT. Separate from the leaseback of the property by the SLT-seller ' which must be tantamount to an independent, stand-alone transaction ' Statement of Financial Accounting Standards (“SFAS”) 98 requires that “the payment terms and provisions” in an SLT “must clearly transfer all of the other risks and remedies of ownership as is demonstrated by the absence of any other continuing involvement by the seller/lessee.” Thus, according to Ernst & Young, for instance, options to repurchase the property by the seller/lessee are generally prohibited as a form of “continuing involvement” under SFAS 98. Ernst & Young, Financial Reporting Developments, Sept. 2003 L716, p. 130. Even rights of first refusal must be based upon bona fide offers from unrelated third parties; otherwise, they too would be considered options to repurchase the property that will taint the “operating lease” status of the SLT. Id. In fact, SFAS 13 specifically defines a “capital lease” (which characterization would defeat the benefits accruing to the balance sheet of the SLT-seller/lessee if the leaseback were treated as an “operating lease”) as a lease where “(1) the lease transfers ownership of the property to the lessee by the end of the lease term; or (2) the lease contains a bargain option.”

Any lease not classified as a “capital lease” is classified as an “operating lease,” the characterization virtually always the more favorable to SLT-seller/lessees. As stated above, when the leaseback portion of the SLT is treated as an “operating lease,” an asset (cash and/or an account receivable which is derived from the sale portion of the SLT) is added to the balance sheet with no corresponding liability even though the SLT-seller/lessee retains possession and use of the property conveyed in fee, although a footnote disclosure respecting the leaseback portion of the SLT is often required. (See SFAS 13 at '16). This asset increase without an offsetting increase in liabilities, when coupled with the beneficial inconsistent treatment for financial versus tax statement presentation, is the “holy grail” sought via the SLT.

The length of term of the leaseback in the proposed SLT is also an important element. Many existing long-term leases that would be candidates for SLTs have terms of 49 or more years. The proposed basic lease term in a bondable SLT, however, is customarily for 15 or 20 years. Even with the generally allowable six renewal terms of up to 5 years each, this could leave the seller/lessee with a shorter possessory period than it currently has because, under SFAS 13, an option to repurchase the property is not allowed. Although the “length” of term issue can be partially addressed by providing for fair-market value lease extension rights, this will no doubt have some impact on the deal economics, thereby creating yet another potential complication. Moreover, if the lease extension option is not determined to be at fair market, the lease would then be characterized as a “capital lease” with the concomitant loss of “financial presentation” benefits. (Another issue in this context that needs to be weighed in the economics in certain tax jurisdictions is whether a leaseback to the seller/lessee for more than 49 years would require payment of a second transfer tax, in addition to the first transfer tax that would be imposed at the time of the initial sale.)

Another accounting hurdle that must be overcome to obtain favorable “operating lease” accounting treatment under SFAS 98 requires that the SLTs “payment terms and provisions … adequately demonstrate the (SLT) buyer-lessor's initial and continuing investment in the property” and, of course, the corollary, that the SLT-seller/lessee has no “continuing involvement” in the property. Hence, for example, while the condemnation or casualty loss provisions under the leaseback portion of the SLT might typically allow for a termination of the SLT-seller/lessee's obligation to continue paying rent upon a substantial condemnation or casualty loss because the SLT-seller/lessee will not have use of the property, the economic underpinning of the SLT nevertheless requires that the SLT-buyer/lessor be made whole. Whatever termination fee is agreed upon to make an SLT-buyer/lessor “whole” for its purchase price or loan equivalent, however, cannot be dependent upon, or determined by, the value of the property at the time of the loss, because it would violate the accounting requirements under the “continuing involvement” theory. In fact, under the accepted accounting treatment, only a damages provision or termination fee that does not take into account appreciation or depreciation of the property (lest the SLT-buyer/lessor be “compelled” to accept the SLT-seller/lessee's offer) might be acceptable. In other words, terms worked out and satisfactory to the parties, which are nevertheless deemed too favorable to the SLT-buyer/lessor, might prevent obtaining “operating lease” accounting treatment. As expressed earlier, SLTs are too time consuming and expensive not to resolve these significant points at the outset.

As alluded to earlier, while FASB criteria, and in particular SFAS 13 and SFAS 98, provide clear-cut tests to be followed, the tax law in this area is less clear and the IRS “safe harbors” often seem to be under severe mist if not fog. Nevertheless, taxpayers challenging adverse IRS sale-leaseback characterization have had some successes in the courts. Perhaps, the leading sale-leaseback case is Frank Lyon Co. v. U.S., 435 U.S. 561 (1978) revising 536 F2d 746 (8th Cir. 1976), revising and remanding 75 USTC '9545 (E. D. Ark 1975). (“Lyon“) in which the U.S. Supreme Court summarized the relevant criteria in analyzing an SLT, even though the Court failed to provide explicit guidelines for differentiating true sale-leasebacks (ie, “operating leases”) from financing arrangements (ie, “capital leases”). Subsequent Tax Court decisions and particularly the literature analyzing these cases, however, do suggest the elements or “thresholds” that should be included in an SLT in order to avoid an IRS challenge. Holthouse's Tax Management sets forth a useful checklist:

1) The property should be sold at fair market value, the amount of which is supported by an independent appraisal.

2) Rent should be fair market value and also supported by independent appraisal. Level or increasing rental payments are desirable.

3) Multiple (more than two) parties are recommended: the seller-lessee, the buyer-lessor, and, preferably, an institutional lender.

4) The lease term should not exceed the economic life of the property. Renewal options should provide for a fair market rental value at the time the option is exercisable.

5) There should be no repurchase options. If one is necessary, ideally it should be based on the fair market value of the property at the exercise date.

6) All condemnation and insurance payments in excess of liabilities on the property should inure to the buyer-lessor.

7) There should be a business purpose for the transaction and the formalities of the agreement should be followed. The agreement should avoid loan language or structure.

8) A substantial cash return on the leaseback should be included to avoid having the transaction viewed as being created solely for tax purposes.

9) The lease should not be structured as a pure net lease.

10) The sale-leaseback should be designed to qualify as an operating lease under GAAP. (See SFAS 13 and 98)

11) The leaseback should terminate in the event the property is destroyed.

12) If possible, the term of the leaseback should be less than 30 years.

13) Two entirely different sets of documents should be drafted, one for the sale of the real estate and one for the lease agreement.

14) The buyer-lessor should make an equity investment in the property.

15) The seller-lessee should not provide guarantees of the loans financing the purchase of the property (although a pledge of the lease would not be uncommon).

16) The transaction should not be between related parties.

17) The buyer-lessor should not have a put on the property.

18) The seller-lessee should not possess the right to sell the property without the buyer-lessor's consent.

19) The transaction should be structured so that the buyer-lessor can meet the so-called imprudent abandonment test. This means that the buyer-lessor must be able to demonstrate that he or she: (i) has made more than a negligible investment in the property, (ii) possesses more than a negligible right to receive rents, and (iii) reasonably anticipates more than a negligible return from the right to enjoy the residual value of the property.

Holthouse's Tax Management at pps. A-56 and A-56(1).

Conclusion

This article highlights some of the potential accounting pitfalls on the path to obtaining “operating lease” status for the leaseback portion of an SLT. (Extensive footnotes are available from the authors.) SLTs are effective devices to enhance a balance sheet in the context of raising liquidity from the sale of realty while maintaining possessory and use status quo. However, they have become somewhat less attractive in the post-Enron era, perhaps due to an intuitive sense that the SLT device is somehow counterintuitive by virtue of the disproportionately positive impact to the balance sheet of the SLT-seller/lessee, notwithstanding that which looks, on the surface, and from an operational perspective, as if it maintains the status quo ante. As a result, it is not surprising that accounting firms put SLTs under an even more magnified glass to assure themselves that the leaseback component of the SLT should be treated as an “operating lease.”

This heightened scrutiny by the accountants (and tax lawyers) should not be a reason to forego an SLT; rather, it should merely alert clients and their counsel to “bring on the terms” to all interested parties early in the process, thereby avoiding the excess costs that flow together with the agony of a deal that aborts late in the process. Moreover, involving the accountants and tax lawyers early on will probably enable the parties to more easily find practical solutions, when flexibility on both sides is generally the greatest.

In the era following Enron, Worldcom, Tyco, IMClone and Martha Stewart, when fraudulent actions, or even alleged fraudulent actions, can cause significant stock market losses, those operating “on the edge,” if found guilty of “going over the edge,” may face a sentence that could include incarceration as well as economic punishment.

Since the corporate scandal trials almost always involve financial re-engineering, it is no surprise that these trials and the concomitant publicity would have an impact on sale-leaseback transactions (“SLTs”) and those planning such transactions. It thus should be expected that in the post-Enron era, all financial and accounting transactions will be examined with a heightened degree of scrutiny, particularly those with an aroma of fancy accounting. Corporate executives and outside advisers now know that it is much harder to obtain a free pass for bad accounting. With the stakes for advising aggressively on SLTs having been significantly raised, it follows that SLTs are now becoming increasingly more difficult and complicated to complete.

SLTs have been a favored “financing” technique because a property owner can obtain more capital from the “sale portion” of an SLT than by retaining ownership and arranging a conventional mortgage. SLTs allow the property owner to realize up to 100% of the fair market value of the property ' significantly above what traditional loan-to-value lending would provide ' while retaining full possession and use of the property. Of even greater importance, if the leaseback portion of the SLT is treated for financial accounting purposes as a true “operating lease” (as opposed to a “capital lease”), the seller will be able to strengthen its financial statements because the full amount of the proceeds from the sale of the property will be treated on the balance sheet as an increase in assets, and the seller will retain possession and use of the property without an offsetting liability on the balance sheet (although a footnote to the balance sheet will be required).

An SLT, however, is almost always more complicated to close than a conventional mortgage. Such is the case because: 1) restrictions imposed by the SLT lessor on use of the underlying property by the SLT-seller/lessee are often more onerous than with conventional financing; 2) there are always more parties at the table; and 3) the accounting requirements are significantly more restrictive, often flying in the face of real estate as well as economic realities, thereby giving the business parties much pause. As a result, most SLTs are entered into by sellers who are primarily motivated by a desire to enhance their balance sheet. Hence, they are more willing to endure burdensome lease restrictions and work through a more complicated transaction. See Jeffrey H. Newman and Mark S. Levenson, Sale-Leaseback Transactions after Enron and Worldcom ' A Tougher Landscape, New Jersey Business, October 2002.

Business Concerns

Each SLT is driven by the business realities impacting the particular deal. For instance, the prospective purchaser (SLT-lessor) 1) will likely want significant restrictions on the ability of the SLT-seller/lessee to transfer the property during the lease period, unless a credit guarantee remains in place; 2) may want approval rights regarding transfers; 3) might insist on higher standards of maintenance and/or an enhanced capital replacement program (thereby creating negative impact on the deal economics); 4) may want input or perhaps even veto rights with respect to any significant management issues relating to the property; and 5) could have conflicting views on the development of adjacent property if owned or becomes owned by the SLT-seller/ lessee. Although the overall economics of the SLT (ie, the sale price in relation to the lease carry costs) may make all of the foregoing of minor concern to the SLT-seller/lessee, these issues, nonetheless, must be worked through and reconciled. While having a “rated” guarantor of the SLT-seller/lessee or a “rated” SLT-seller/lessee lessens the concerns of the purchaser/lessor on the foregoing issues, because the purchaser/lessor could then look primarily to the creditworthiness of the guarantor or SLT-seller/lessee, as opposed to the real property collateral, significant negotiation on these issues is still likely.

Another area of concern that often complicates an SLT is environmental. Even with the credit of a strong guarantee, a lender funding the SLT will require a comprehensive environmental review. The environmental review, depending on the lender's requirements and whether there may be a future securitization, can be more rigorous and may therefore necessitate enhanced environmental remediation or the implementation of additional environmental compliance and maintenance programs beyond that which might have been required in a conventional mortgage. Thus, notwithstanding scope and quality, creditworthiness by itself may not be enough to vitiate the higher environmental standards that may be required by a lender.

Accounting Treatment

As noted above, the structure of an SLT is often dictated by the accounting requirements necessary to obtain “operating lease” characterization. What may be agreed to in a term sheet between a motivated SLT-seller/lessee and SLT-purchaser/lessor may not survive the required accounting hurdles. Post-Enron, accounting firms are even more conservative in their approach to granting “operating lease” status to the leaseback portion of SLTs. The major accounting firms, in particular, will often hew to the black and white of the accounting industry guidelines and their manuals and are unwilling to go into the gray. SLTs are further complicated by the fact that the Financial Accounting Standards Board (“FASB”) financial accounting criteria are not identical to published Internal Revenue Service (“IRS”) guidance. FASB provides more bright-line tests that are, therefore, safer to work with than the IRS' safe harbors, which are not bright line and even less consistently market realistic. (On account of the sometimes non-identical treatment, some transactions are structured to take advantage of these differences to obtain the benefit of inconsistent book and tax treatment, ie, an “operating lease” for book purposes and “a financing” for tax purposes, to avoid a gain on any appreciation. Holthouse, 593 Tax Management (BNA), Real Estate Leases, Section VI, SLTs at A-49 through A-56(1) (“Holthouse”)). Reconciling these potentially conflicting FASB and IRS guidelines requires creativity, patience and special effort to achieve the parties' respective goals and yet remain in respective compliance.

To accomplish this, as well as “operating lease” treatment, the accounting requirements applicable to the proposed transaction should be ascertained in light of the SLT-seller/lessee's specific objectives at the early stages of the transaction. In so doing, before unnecessary time and cost is expended, the parties can determine their ability to 1) meet the applicable accounting requirements; and 2) adjust the proposed transaction in order to satisfy the accounting requirements in a manner that will not interfere with the attainment of the SLT-seller/lessee's financial goals from the proposed SLT.

While this article should not be construed as providing accounting or tax advice, it is appropriate to highlight some of the major accounting issues in a proposed SLT. Separate from the leaseback of the property by the SLT-seller ' which must be tantamount to an independent, stand-alone transaction ' Statement of Financial Accounting Standards (“SFAS”) 98 requires that “the payment terms and provisions” in an SLT “must clearly transfer all of the other risks and remedies of ownership as is demonstrated by the absence of any other continuing involvement by the seller/lessee.” Thus, according to Ernst & Young, for instance, options to repurchase the property by the seller/lessee are generally prohibited as a form of “continuing involvement” under SFAS 98. Ernst & Young, Financial Reporting Developments, Sept. 2003 L716, p. 130. Even rights of first refusal must be based upon bona fide offers from unrelated third parties; otherwise, they too would be considered options to repurchase the property that will taint the “operating lease” status of the SLT. Id. In fact, SFAS 13 specifically defines a “capital lease” (which characterization would defeat the benefits accruing to the balance sheet of the SLT-seller/lessee if the leaseback were treated as an “operating lease”) as a lease where “(1) the lease transfers ownership of the property to the lessee by the end of the lease term; or (2) the lease contains a bargain option.”

Any lease not classified as a “capital lease” is classified as an “operating lease,” the characterization virtually always the more favorable to SLT-seller/lessees. As stated above, when the leaseback portion of the SLT is treated as an “operating lease,” an asset (cash and/or an account receivable which is derived from the sale portion of the SLT) is added to the balance sheet with no corresponding liability even though the SLT-seller/lessee retains possession and use of the property conveyed in fee, although a footnote disclosure respecting the leaseback portion of the SLT is often required. (See SFAS 13 at '16). This asset increase without an offsetting increase in liabilities, when coupled with the beneficial inconsistent treatment for financial versus tax statement presentation, is the “holy grail” sought via the SLT.

The length of term of the leaseback in the proposed SLT is also an important element. Many existing long-term leases that would be candidates for SLTs have terms of 49 or more years. The proposed basic lease term in a bondable SLT, however, is customarily for 15 or 20 years. Even with the generally allowable six renewal terms of up to 5 years each, this could leave the seller/lessee with a shorter possessory period than it currently has because, under SFAS 13, an option to repurchase the property is not allowed. Although the “length” of term issue can be partially addressed by providing for fair-market value lease extension rights, this will no doubt have some impact on the deal economics, thereby creating yet another potential complication. Moreover, if the lease extension option is not determined to be at fair market, the lease would then be characterized as a “capital lease” with the concomitant loss of “financial presentation” benefits. (Another issue in this context that needs to be weighed in the economics in certain tax jurisdictions is whether a leaseback to the seller/lessee for more than 49 years would require payment of a second transfer tax, in addition to the first transfer tax that would be imposed at the time of the initial sale.)

Another accounting hurdle that must be overcome to obtain favorable “operating lease” accounting treatment under SFAS 98 requires that the SLTs “payment terms and provisions … adequately demonstrate the (SLT) buyer-lessor's initial and continuing investment in the property” and, of course, the corollary, that the SLT-seller/lessee has no “continuing involvement” in the property. Hence, for example, while the condemnation or casualty loss provisions under the leaseback portion of the SLT might typically allow for a termination of the SLT-seller/lessee's obligation to continue paying rent upon a substantial condemnation or casualty loss because the SLT-seller/lessee will not have use of the property, the economic underpinning of the SLT nevertheless requires that the SLT-buyer/lessor be made whole. Whatever termination fee is agreed upon to make an SLT-buyer/lessor “whole” for its purchase price or loan equivalent, however, cannot be dependent upon, or determined by, the value of the property at the time of the loss, because it would violate the accounting requirements under the “continuing involvement” theory. In fact, under the accepted accounting treatment, only a damages provision or termination fee that does not take into account appreciation or depreciation of the property (lest the SLT-buyer/lessor be “compelled” to accept the SLT-seller/lessee's offer) might be acceptable. In other words, terms worked out and satisfactory to the parties, which are nevertheless deemed too favorable to the SLT-buyer/lessor, might prevent obtaining “operating lease” accounting treatment. As expressed earlier, SLTs are too time consuming and expensive not to resolve these significant points at the outset.

As alluded to earlier, while FASB criteria, and in particular SFAS 13 and SFAS 98, provide clear-cut tests to be followed, the tax law in this area is less clear and the IRS “safe harbors” often seem to be under severe mist if not fog. Nevertheless, taxpayers challenging adverse IRS sale-leaseback characterization have had some successes in the courts. Perhaps, the leading sale-leaseback case is Frank Lyon Co. v. U.S., 435 U.S. 561 (1978) revising 536 F2d 746 (8th Cir. 1976), revising and remanding 75 USTC ' 9545 (E. D. Ark 1975). (“ Lyon “) in which the U.S. Supreme Court summarized the relevant criteria in analyzing an SLT, even though the Court failed to provide explicit guidelines for differentiating true sale-leasebacks (ie, “operating leases”) from financing arrangements (ie, “capital leases”). Subsequent Tax Court decisions and particularly the literature analyzing these cases, however, do suggest the elements or “thresholds” that should be included in an SLT in order to avoid an IRS challenge. Holthouse's Tax Management sets forth a useful checklist:

1) The property should be sold at fair market value, the amount of which is supported by an independent appraisal.

2) Rent should be fair market value and also supported by independent appraisal. Level or increasing rental payments are desirable.

3) Multiple (more than two) parties are recommended: the seller-lessee, the buyer-lessor, and, preferably, an institutional lender.

4) The lease term should not exceed the economic life of the property. Renewal options should provide for a fair market rental value at the time the option is exercisable.

5) There should be no repurchase options. If one is necessary, ideally it should be based on the fair market value of the property at the exercise date.

6) All condemnation and insurance payments in excess of liabilities on the property should inure to the buyer-lessor.

7) There should be a business purpose for the transaction and the formalities of the agreement should be followed. The agreement should avoid loan language or structure.

8) A substantial cash return on the leaseback should be included to avoid having the transaction viewed as being created solely for tax purposes.

9) The lease should not be structured as a pure net lease.

10) The sale-leaseback should be designed to qualify as an operating lease under GAAP. (See SFAS 13 and 98)

11) The leaseback should terminate in the event the property is destroyed.

12) If possible, the term of the leaseback should be less than 30 years.

13) Two entirely different sets of documents should be drafted, one for the sale of the real estate and one for the lease agreement.

14) The buyer-lessor should make an equity investment in the property.

15) The seller-lessee should not provide guarantees of the loans financing the purchase of the property (although a pledge of the lease would not be uncommon).

16) The transaction should not be between related parties.

17) The buyer-lessor should not have a put on the property.

18) The seller-lessee should not possess the right to sell the property without the buyer-lessor's consent.

19) The transaction should be structured so that the buyer-lessor can meet the so-called imprudent abandonment test. This means that the buyer-lessor must be able to demonstrate that he or she: (i) has made more than a negligible investment in the property, (ii) possesses more than a negligible right to receive rents, and (iii) reasonably anticipates more than a negligible return from the right to enjoy the residual value of the property.

Holthouse's Tax Management at pps. A-56 and A-56(1).

Conclusion

This article highlights some of the potential accounting pitfalls on the path to obtaining “operating lease” status for the leaseback portion of an SLT. (Extensive footnotes are available from the authors.) SLTs are effective devices to enhance a balance sheet in the context of raising liquidity from the sale of realty while maintaining possessory and use status quo. However, they have become somewhat less attractive in the post-Enron era, perhaps due to an intuitive sense that the SLT device is somehow counterintuitive by virtue of the disproportionately positive impact to the balance sheet of the SLT-seller/lessee, notwithstanding that which looks, on the surface, and from an operational perspective, as if it maintains the status quo ante. As a result, it is not surprising that accounting firms put SLTs under an even more magnified glass to assure themselves that the leaseback component of the SLT should be treated as an “operating lease.”

This heightened scrutiny by the accountants (and tax lawyers) should not be a reason to forego an SLT; rather, it should merely alert clients and their counsel to “bring on the terms” to all interested parties early in the process, thereby avoiding the excess costs that flow together with the agony of a deal that aborts late in the process. Moreover, involving the accountants and tax lawyers early on will probably enable the parties to more easily find practical solutions, when flexibility on both sides is generally the greatest.