Prepaid Lease

3 minutes read
Last updated: November 6, 2023


  • A prepaid lease is a tax-efficient technique to structure a sale of long-lived tangible assets, including real estate, plant, and equipment. The basic structure involves a prepaid long-term lease of the asset being sold in which the Buyer obtains the option to acquire the asset outright at the end of the lease term. Subject to confirmation from outside tax counsel, the Seller can typically receive 80-90% of the fair value of the asset sold through an up-front prepaid rent payment, and receive a strong tax opinion that the tax liability is amortized into income over the lease term (typically 20-30 years)
    • For an asset with long-term economic useful life, a prepaid long-term lease can cut the present value of the Seller’s tax liability by 50-60%
  • Core requirements:
    • Lease Term: The lease term cannot exceed 80% of the remaining economic useful life of the asset
    • Residual Value: The estimated fair value of the property at the end of the lease term must equal at least 20% of the original cost of the asset
    • Purchase Option: The option to purchase the asset must be a reasonable estimate of fair value at the end of the lease term (i.e. it can’t be a “bargain option”)
  • Core benefits:
    • Tax: Outside tax counsel generally will opine that Seller’s tax liability is amortized on a yield-to-maturity basis over the lease term (i.e. significant deferral), rather than being triggered up-front
    • GAAP: Seller generally converts one-time book gain into periodic rental income over lease term
  • Key issues:
    • Buyer’s tax depreciation obtained in straight purchase converted to rental expense over lease term. Depending on the tax depreciation life of the asset and the lease term, may impose a cost upon Buyer
    • Asset stays on Seller’s balance sheet
    • Buyer subject to Seller bankruptcy risk
  • Precedent transactions: Alltel/American Tower, SBC/SpectraSite

Transaction Structure

Initial Step Purchase Option Exercise at Lease-End

Exhibit – Benefits & Considerations

Benefits Considerations
  • Lessor/Seller initially receives up to 80-90% of the current fair valued of the asset in up-front cash proceeds (likely to be greater than after-tax proceeds from a taxable sale)
  • Wide variety of assets eligible for this structure
    • Assets with a long remaining useful life (e.g. 20 years or more) are optimal because the benefits of deferral to Lessor/Seller are greatest
  • Rental income may be amortized into earnings over life of lease and included in EBITDA (depending on type of asset transferred and/or the terms of the lease)
  • Purchaser does not obtain legal title to asset and may be reluctant to undertake Seller bankruptcy risk
  • Purchaser may extract value to reflect difference, if any, between value of tax depreciation in an outright purchase and value of rental deductions over lease term

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