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S Corporation CPA discusses Leasebacks as an Alternative Financing technique | Form 1120-S CPA

S Corporation CPA Wilmington NC Form 1120-S CPA

Gary Bode, CPA: alternative financing techniques deserve careful analysis. (910) 399-2705.

S Corporation CPAs see more clients turning to alternative financing techniques, like leasebacks, during the recession. I’ve posted on other alternative financing techniques: purchase order financing and accounts receivable factoring. Leasebacks are popular in real estate. But in this post I’m using an industrial manufacturing scenario.

Simplistic Leaseback Example

Wilmington NC Inc., an S Corporation, owns a large crane. For whatever reasons, the S Corporation, needs operating capital and can’t tap into more conventional financing options. Wilmington NC Inc. sells the crane to Bank 1120-S. Bank 1120-S buys the crane for a lump sum and then leases it back to Wilmington NC Inc. for $X/month.

Potential Leaseback Pros

  • Frees up the equity Wilmington NC Inc. had in the crane. This translates into a lump sum of cash the S Corporation can use at its discretion.
  • May improve the S Corporation’s cash flow. Say Wilmington NC Inc. was paying $3500/month to finance the crane. The new lease from Bank 1120-S might be for a longer term at monthly payments of $2000/month.
  • Sometimes the new lease has more flexible terms.
  • The gain, if any, from the sale, might offset prior Net Operating Losses set to expire.

“The pros and cons of leasebacks deserve careful analysis.”
– Gary Bode, Form 1120-S CPA

Where does the S Corporation CPA Factor in?

Small and mid-size S Corporations generally don’t have a trained CFO or CPA on staff. Alternative Financing techniques require careful analysis. So, the Form 1120-S CPA is called in to help. First I identify all the quantitative parameters. Next I study the subjective parameters. Typically I’ll prepare multiple scenarios to review with S Corporation managers and officers.

Leaseback Quantitative Parameters

  • Sale price. Usually the fair market value of the crane. What is the FMV? It depends.
  • Is there a gain of loss on the sale? If so how much? Depreciation and original purchase price must be known to find book value.
  • Monthly lease payment.
  • Lease term.
  • Lease conditions. Typically Wilmington NC Inc. still pays the taxes, some repairs and insurance.
  • Type of lease: operating or capital?
  • Implicit interest rate. Bank 1120-S doesn’t enter into the leaseback without a profit motive.
  • Effect of leaseback on existing loan covenants.
  • Tax consequences of the sale to Wilmington NC, Inc.
  • Tax consequences of the new lease to the S Corporation.

Subjective Parameters of Leasebacks

  • Intended use of the leaseback lump sum payment. Here a forecast budget is appropriate. Will the new capital be enough?
  • Expected life left on the crane.

Potential Leaseback Cons

  • Bank 1120-S will make a profit over the lifetime of the lease. The implicit interest rate may be higher than other sources of capital.
  • Wilmington NC, Inc. could be liable for lease payments even after the crane becomes obsolete.
  • Wilmington NC, Inc. could lose the right to the crane once the lease expires. So what about the $1 buyback clause? That turns the operating lease into a capital lease which has tax consequences.
  • Tax consequences. The IRS can disqualify a leaseback agreement. The main point of contention? The leaseback can’t be primarily for avoiding taxes.
  • You don’t own the crane anymore. If Bank 1120-S goes bankrupt (remember recent history), they could lose the crane and so you lose the crane.
  • During the life of the leaseback, Wilmington NC, Inc. might pass up better opportunities for financing.

Leaseback Suggestions

  • Run multiple leaseback scenarios using the numbers and factor in the subjective parameters.
  • Be sure the leaseback agreement follows IRS guidelines.

I’m an S Corporation CPA that operates as an S Corporation. So I keep with all S Corporation and Form 1120-S issues. We have a virtual office to offer greater convenience to local clients. Note we can serve you almost irregardless of where you live. We have national and international clients. There are hundreds of postings on this site, dozens on S Corporations and Form 1120-S issues. Please read a few to help gauge my abilities and philosophy. For a free phone consult please call (910) 399-2705.

2 comments to S Corporation CPA discusses Leasebacks as an Alternative Financing technique | Form 1120-S CPA

  • John Tillman

    Hello Mr. Bode,
    I read your profile and know you can give me an idea on Tax Ramification of S Corporation Financing Alternatives. Based on the scenario posted below, I would need an explanation at your convenience how can I go about preparing a Tax Memorandum. I am a college student.
    One of your wealthy clients, Cecile, invests $100,000 for sole ownership of an electing S corporation’s stock. The corporation is in the process of developing a new food product. Cecile anticipates that the new business will need approximately $200,000 in capital (other than trade payables) during the first two years of its operations before it starts to earn a sufficient profits to pay a return on the shareholder’s investment. The first $100,000 of this total is to come from Cecile’s contributed capital. The remaining $100,000 of funds will come from one of the following three sources:
    1. Have the corporation borrow the $100,000 from a local bank. Cecile is required to act as a guarantor for the loan.
    2. Have the corporation borrow $100,000 from the estate of Cecile’s late husband. Cecile is the sole beneficiary of the estate.
    3. Have Cecile lend $100,000 to the corporation from her personal funds.

    The S corporation will pay interest at a rate acceptable to the IRS. During the first two years of operations, the corporation anticipates losing $125,000 before it begins to earn a profit. Your tax manager has asked you to evaluate the tax ramifications of each of the three financing alternatives. Prepare a memorandum (citing applicable sources, such as the IRC) outlining the information you found in your research.

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