Sale-Leasebacks for Family Businesses and Succession Planning

A family that has run a business for a generation or two usually owns two things of real value: the operating company and the building it works from. The founders' retirement depends on getting money out of one or both. The next generation's future depends on the company staying healthy.

Those goals pull against each other. The successors rarely have the cash to buy out their parents. Borrowing it loads the company with debt at the moment leadership is changing. Meanwhile there may be siblings who do not work in the business and who expect, reasonably, to share in the family's wealth. The building sits in the middle of all of it.

Many families already hold the building in a separate entity that leases it to the company. Where the building is still owned by the operating company itself, advisors often recommend separating the two, so that the real estate and the business can have different owners and different futures. How to do that, and what it costs in tax, is a question for your attorney and CPA.

Once they are separate, the family has choices. The business can pass to the children who run it. The real estate can be kept by the parents, shared among all the children, or sold. A sale-leaseback is the version in which the real estate is sold to an outside investor and the company signs a lease with that investor.

If the family keeps the building and leases it to the company, the rent between related parties needs attention. IRS Publication 334 states that a business cannot take a rental deduction for unreasonable rent, that reasonableness usually becomes a question only when the tenant and landlord are related, and that rent paid to a related person is reasonable if it is the same amount you would pay to a stranger for the same property. Set family rent with that standard in mind and review it with your CPA.

• Liquidity for the retiring generation. The founders receive cash from the sale without the company borrowing to pay them and without selling the business.
• A fair division among heirs. Cash can be divided among children in ways a building cannot. Those who run the company take the company; others can receive value from the proceeds.
• An arm's-length landlord. Rent, repairs and renewals are governed by a written lease with an outsider, which removes a recurring source of family conflict.
• Diversification. Family wealth that was concentrated in one building tied to one company can be spread across other investments.
• Capital for the successors. If some proceeds stay in the company, the next generation starts with resources to invest.

Notice that these benefits depend on where the proceeds go. If the building is owned by the parents' entity, the cash goes to the parents. If it is owned by the company, the cash arrives in the company and getting it to shareholders is a separate step with its own tax consequences. Establish who owns the property, and therefore who receives the money, before any other planning.

A sale-leaseback is not free money for the family. It moves value from the future to the present, and the successors are the ones who live with the result.

• A permanent rent obligation. The company will pay rent, usually with scheduled increases, for the full lease term. That lowers the earnings available to the successors and the value of the company if they later sell it.
• Loss of the asset. Any future appreciation belongs to the investor. The building is no longer there as collateral or as a reserve of value in a hard year.
• Less flexibility. The successors cannot close, shrink or relocate the operation without regard to the lease.
• Taxable gain now. A sale is a taxable event. IRS Publication 544 explains that gain is the amount realized over the property's adjusted basis, and a long-held, heavily depreciated building often has a low basis. Whether selling is better than holding the property as part of an estate plan is a question for your estate planning attorney and CPA, because the answer turns on your family's facts.

A fair succession plan acknowledges this trade openly. The retiring generation is being paid in part with rent the next generation will owe.

A sale-leaseback is one of several ways to deal with the building in a succession plan. A family should understand all of them.

• Keep the building in the family and lease it to the company. The parents, or all the children, receive rental income. The asset stays in the family, along with the conflicts of being landlord to a relative.
• Refinance. A mortgage on the building can fund part of a buyout while the family keeps ownership. The company or the real estate entity takes on debt that must be repaid.
• An internal sale over time. The successors buy the business or the building from the parents with payments over a period of years. This requires little outside capital and leaves the parents dependent on the company's performance.
• Sell the company and the building together. If no family member wants to continue, a combined sale may be simplest.
• Sell the building and relocate. If the successors would prefer a different size or location, a vacant sale may fit better than a leaseback.

• ✓Who holds title to the building today, and who would receive the sale proceeds?
• ✓How much does the retiring generation need, and by when?
• ✓Do the successors intend to run the business from this site for the full lease term?
• ✓Can the company comfortably afford market rent, including increases, in a weak year?
• ✓How will family members outside the business be treated, and do they agree?
• ✓What does our CPA estimate the tax on a sale would be, and how does that compare with holding the property?
• ✓Does our estate planning attorney see a reason to keep or to sell the real estate?
• ✓Will the investor require personal guaranties, and from which generation?
• ✓Do the lease terms leave the successors able to sell the company later?

TAG works with family-owned companies as the seller's and future tenant's representative. We start with the family's objectives and the building's realistic value, and we negotiate the lease with the next generation's operating needs in mind, alongside the family's attorney and CPA.