By Maureen Kelly Cooper
Three key components of the new tax law may cause previous own vs. lease analysis to have a different outcome this time around. First, the corporate tax rate has been reduced from 35 percent to 21 percent. Second, the cap on tax deductibility of interest expense has fallen from 100 percent to 30 percent. And third, there’s a doubling of bonus depreciation to 100 percent and an expansion of qualified assets to include used assets.
So, what does all of this mean?
In the past, when evaluating real estate alternatives, companies that owned property with a low tax basis could have found that continuing to own was the preferred alternative to leasing. This might have been the result of a tax hit from a gain on the sale and/or the possibility that depreciation and interest benefits of ownership outweighed the benefits of leasing.
Let’s take a look at the impact of the new tax law on a $20 million property sale.
In this example, the company will realize an increased net cash flow of 14 percent, or $2.1 million.
Also affecting the own vs. lease decision will be the cap on tax deductibility of interest expense. Prior to the passage of the new tax legislation, corporations had the ability to deduct 100 percent of their interest expense. The amended tax code caps the deduction at 30 percent of EBIT (earnings before interest and taxes). Without the benefit of full interest expense deductibility, companies may be inclined to lease in order to capture the 100 percent deductibility of rental payments.
In addition, the acceleration of depreciation benefits for tax may impact the own vs lease outcome. “Qualified Improvement Property” depreciation now expands to used assets, and bonus depreciation has increased to 100 percent. Qualified improvement property will enable companies to accelerate the write-off of the buildout of their interior improvements, whether they lease or own the property.
When it comes to evaluating an own vs. lease decision for your business, there has never been a “one-size-fits-all” solution. In addition to the new tax implications, the following factors should also be considered:
- Cost of capital/opportunity cost of funds
- Strength of the capital and real estate markets
- Functional obsolescence of real estate and/or cost to replicate a strategic asset
- Impact to a company’s financial statements
Decisions based on old rules and regulations may no longer be the best practice for your company’s real estate needs.
As a result of the new tax laws, the new FASB rules, and the continued strength of the credit tenant-backed real estate market, every corporation should make evaluating their real estate strategy a top priority in 2018.
Maureen Kelly Cooper is an Executive Director in Cushman & Wakefield’s Corporate Capital Markets Group.