From a tax perspective the fundamental issue is whether a legitimate business purpose exists for the formation of a distinct entity to do a sale leaseback. If one exists and this is pursued all elements of the transaction should meet an arms length standard and be at fair market value.
For a sale-leaseback, the business owner will set up a new LLC and then under an arms length transaction, sell the asset to the LLC and immediately enter into a lease for this property from the LLC. If the primary purpose of this strategy is to raise more capital, then it is necessary to find the investor who will be putting the cash into the LLC. The primary disadvantage in considering this strategy is the small business owner is giving up some of the profits in the business via the lease payments.
The primary caution in considering this strategy is you must understand the transaction must be an “arms-length” transaction for both the sale to the LLC and the leaseback of the asset from the LLC. A secondary issue is whether the lease qualifies as an operating lease or a capital lease. The third issue, which may be the most critical to many small businesses, is have you given up your primary asset that may be critical for your use as collateral for your overall debt structure? Most likely, the business owner will have to pay taxes at the time of the sale.
If the motivation is to transfer ownership in assets to other family members or employees, this transaction may be structured more along the lines of a gift-leaseback. In order to determine the value of the gift into the LLC, you must obtain an appraisal of the fair market value of the equipment. This strategy would normally only be considered by a business that would conclude that it is “asset rich.” As with the sale-leaseback, it is important that the lease be at fair market value.
This strategy could afford the business owner to 1) potentially reduce the size of their taxable estate and 2) potentially shift some income and cash flow to either family members or key employees.
For any gifting, be sure to familiarize yourself with the gift tax and estate tax implications. A major factor in evaluating this strategy is whether the assets transferred will be appreciating in value. Another factor as discussed above, is whether the business owner will need the assets for collateral in the future. And, the business owner needs to make a long-term estimate of the cash flow impact on the business.
Take care to determine if a gift tax return must be filed or in the case of employees, if the transfer constitutes taxable compensation. Also don't overlook the new LLC’s ability to take depreciation on the assets.
The final aspect of considering this topic is control. In these transactions, the business owner may be giving up control over assets that are key to the business. An extension of this question is to consider if future asset purchases will be made by the newly created LLC or inside the business.
If the concern is legal liability, then this is a discussion to be had with their legal counsel and not their CPA/financial planner. The fundamental question to be raised with their attorney is if you have the assets in another LLC will it limit any of your liability exposures.