Real Estate Group Newsletter – Fall 2018
Tanya Gierut

Ready for the new lease accounting rules?


The Financial Accounting Standards Board’s (FASB’s) new standard for accounting for leases will take effect for public companies and other entities for periods beginning after December 15, 2018. Although early adoption is permitted, other organizations that follow U.S. Generally Accepted Accounting Principles (GAAP) must comply for annual periods beginning after December 15, 2019, and for interim periods beginning a year later. The standard will directly affect companies that lease assets. It will also impact lessors, particularly when negotiating leases with tenants.

The new rules in a nutshell

Accounting Standards Update (ASU) No. 2016-02, Leases (Topic 842) classifies leases into finance leases, which transfer control of assets at the end of their term (think about what we used to call capital leases) and operating leases. Lessees must recognize the latter on their balance sheets as a right-of-use asset and a corresponding lease liability. Traditionally, companies did not report operating leases on their GAAP balance sheets. So, those with substantial operating leases will likely see their reported assets and liabilities increase significantly under the updated guidance.

Lessors will not see much change to their accounting. They will generally continue to classify leases as sales-type, direct financing or operating. However, the leverage lease classification is eliminated.

Changes to lessor accounting

The ASU does include some “targeted improvements” for lessors’ financial statements that are intended to align lessor accounting with both the lessee accounting model and the updated revenue recognition rules. For example, they may be required to recognize some lease payments received as deposit liabilities in cases where the collectibility of lease payments is uncertain.

In addition, the ASU changes the definition of “initial direct costs” to include only incremental costs that would not have been incurred if the lease had not been executed, such as commissions or payments to incentivize an existing tenant to terminate. Costs that were previously included, but would have been incurred even if the lease had not been obtained—for example, fixed employee salaries—are now excluded.

The new standard also requires lessors to separate nonlease components that transfer a good or service to the customer—for example, common area maintenance or utilities—from the lease components. Lessors will account for only the lease components, according to the new ASU.

Negotiation implications

The new rules for leases likely will affect lease negotiations. For example, variable lease payments, such as rental payments based on the Consumer Price Index or a percentage of retail sales, are not included when determining a lessee’s lease asset and liability. For leases with such provisions, the tenant’s initial base rent may be its only reportable fixed payment.

A tenant’s liability for a fixed payment lease generally will be greater than the liability for a variable payment lease. So, expect that some tenants will want to negotiate more variable terms in their lease payment structures for this reason.

In addition, the ASU allows lessees to elect not to recognize assets and liabilities for leases with a term of 12 months or less. This will potentially make shorter terms more desirable, especially for tenants with debt covenants based on liabilities. Alternatively, these tenants may prefer finance leases because interest and amortization expenses would be excluded from their EBIDA (earnings before interest, depreciation and amortization). If so, they might seek finance leases with build-to-suit provisions and bargain purchase options.

Plan ahead

In August, the FASB proposed some simplifications for lessors. At this time, however, it is unclear when those may take effect. In the meantime, do not shrug off the new lease accounting rules because of their greater impact on tenants. Some of your accounting also will change, and lessees will come to the negotiating table looking to minimize the adverse effects on their financial statements and debt covenants.

For more information, contact Mike Kovacs or your ORBA advisor at 312.670.7444. Visit ORBA.com to learn more about our Real Estate Group.

Like-kind exchanges under the new Tax Cut and Jobs Act


The Tax Cuts and Jobs Act of 2017 (TCJA) has provided many new changes that will affect both individuals and businesses. One of those changes relates to like-kind exchanges. Deferred tax treatment for exchanges completed after January 1, 2018 are now only available for real property.

Tax Deferral

Prior to the TCJA, tax deferral on like-kind exchanges was available for real property, depreciable tangible personal property, intangible property and non-depreciable personal property. Beginning January 1, 2018 tax-deferred exchanges are only available for real property.

Like-Kind Qualifications

The rules of a like-kind exchange were not changed under the TCJA, so in order to qualify for a like-kind exchange, the taxpayer must have the following:

  • Like-kind property;
  • Qualifying property;
  • Held for productive use in the transferor’s trade or business or for investment; and
  • Meet the timing requirements for identification (45 days) and receipt of new property (180 days)

Transition Rule

Due to the timing requirements, it is possible that a taxpayer started an exchange of personal property when the TCJA took effect. As a result, there is a transition rule that is in effect for property disposed of on or before December 31, 2017 or property received on or before December 31, 2017. If these exchanges adhere to the 45/180-day rules, then the exchange of personal property will still qualify for deferred tax treatment.

If disposal of personal property does not fall into the transition rule mentioned above, then the sale is subject to the general tax rules governing dispositions of personal property.

The rules of like-kind exchanges can be quite complex. If you think you may benefit from a like-kind exchange or may have already entered into an exchange and are not sure if they qualify for deferred tax treatment, please consult your tax advisor.

For more information, contact Tanya Gierut, at [email protected], or call her at 312.670.7444. Visit ORBA.com to learn more about our Real Estate Group.

Forward Thinking