"The irony is that the assessor treats these transactions as leases,
while the IRS may try to 'recharacterize' them as financial transactions."

It is basic real property tax law that a recent sale of a property between an unrelated buyer and seller is the best indicator of value, unless otherwise explained away. But when it comes to sale leasebacks, it is the job of the experienced property tax attorney to explain why such a sale may actually be a financial transaction, which does not necessarily indicate market value as opposed to a pure real estate transaction.

While office and industrial properties are the subject of sale leasebacks, the most prevalent sector is freestanding retail properties, especially fast food, restaurant and drug store properties under $10 million in value. Many operating companies want to monetize their real estate, thus freeing up their assets for more profitable investments, and maximize the deduction of rent payments in the place of non-deductible amortization costs. Such companies are, in effect, obtaining "100% financing" while still retaining the use of the property. A large third party resale market exists for sale leasebacks, which is often keyed to 1031 exchanges for the purpose of deferring capital gains.

A study of local rental and sale values will generally indicate that net lease rental values and sale-leaseback prices are often 50% or more than the property would command in a straight non-sale leaseback transaction. The assessor naturally seizes upon such higher sale leaseback values. The irony is that the assessor treats these transactions as leases while the Internal Revenue Service may try to "recharacterize" such leases as financial transactions.

New York State courts have long recognized the true nature of most sale leasebacks. As far back as 1963, a court refused to view the sale and leaseback of the Empire State Building as indicative of value because "...where the purchaser took back a ground lease, it is common knowledge that such a tie-in has no bearing on the market value of the land. The sale price of $17 million and the amount of the lease rental are completely interdependent and represent a financial transaction not a real estate deal. Such a tie-in sale is hardly a sale under ordinary circumstance..."

A more recent case held that "actual rent in a sale leaseback transaction may be indicative of fair market rental, but is not necessarily so where the rent has been arbitrarily set." This "may be the case between the landlord and tenant who are affiliated companies or where the rent charged in this instance was found to be the computation of the cost of carrying the property with no relation to fair market rental."

The careful property owner and property-tax attorney must examine the nature of the sale-leaseback transaction and the underlying documents. Typical terms, which indicate that a sale leaseback is a financial transaction rather than a true sale or lease, include the following:

• The lease provides for annual rental rates which are based on the payments needed to amortize the mortgage, which is often up to 100% of the purchase price;
• The lease is triple net; the tenant is liable for all expenses, including real estate taxes, insurance and maintenance costs;
• The lessee has many options to renew the lease or to purchase the property at various times throughout the lease term, i.e., the lessor would not benefit if the property were to appreciate in value); the lessee may make alterations and sublease the property without the consent of the lessor; and
• The lease is guaranteed by the corporate seller.

Another factor indicating that a sale-leaseback is really a financial transaction is the role that the seller-lessee played in locating and developing the subject property. Such development often involves an assemblage of parcels and the sale price and lease rent are obviously related to the above market assemblage costs, which clearly bar the transaction as being indicative of actual market conditions. The construction is also most often a built-to-suit building with the sale price and lease rent keyed to the cost of such a built-to-suit project. the seller-lessee may also absorb many of the acquisition, title and closing costs, which are more typically the responsibility of the buyer.

The views expressed in this article are those of the author and not those of Real Estate Media or its publications.

William D. Siegel is a senior partner in the Oyster Bay law firm of Siegel Fenchel & Peddy, P.C. and the New York State member of the American Property Tax Counsel. He can be reached at wds@nytaxappeal.com