Intense cash flow challenges characterize the construction industry. Generally, construction companies don’t get paid until a project or job phase is completed — and subcontractors may have to wait even longer. If a project has stalled, what do you do?

As a result, there may be times when you need a quick cash infusion and don’t want to deal with the lengthy approval process of a business loan. One possible solution is sale-leaseback financing involving one or more pieces of your construction equipment.

Under a sale-leaseback financing agreement, your construction company sells an asset and then leases it back from the buyer. Selling the asset can give you up to 100% of its cash value. Moreover, you make no immediate sacrifice. You still get to use the equipment, and the added cash flow from the sale may help you pay down debt, buy supplies, upgrade remaining assets or simply improve liquidity.

Besides obtaining a quick influx of cash, contractors have other reasons to choose sale-leaseback financing over retaining ownership, signing a standard lease or taking out a loan. For example, sale-leasebacks are typically less restrictive than other types of financing. And one of these arrangements can be structured as a taxable sale under IRS rules, potentially allowing you to offset the sale gain with other deductions to help reduce future tax obligations. Check out our most recent tax planning guide for more tips!

Regarding revenue recognition, if the arrangement qualifies as financing rather than an outright sale, you recognize income over the lease term. This treatment can help you manage taxable income.

Additionally, you may deduct lease payments on the sold equipment if the IRS treats the lease as an operating lease. These include the stipulation that the buyer transfers to the seller only the right to use the property without transferring ownership rights.

One major disadvantage of sale-leaseback financing is that you give up the flexibility that comes with ownership, including the freedom to modify the asset. Also, typically, you won’t resume ownership at the end of the lease term unless the sale-leaseback agreement includes a repurchase option.

However, including a repurchase option may create accounting complexities. Under U.S. Generally Accepted Accounting Principles (GAAP), accountants classify the arrangement as a finance lease rather than an operating lease if any of the following conditions apply::

•  The lease transfers ownership of the asset to the lessee by the end of the lease term,
• The lease grants the lessee an option to buy the asset that the lessee is reasonably sure to exercise,
• The lease term is for the “major part” of the asset’s remaining economic life,
• The present value of lease payments substantially equals or exceeds the asset’s fair value, or
• The asset is of such a specialized nature that it’s expected to have no alternative use for the lessor at the end of the lease term.

If a leaseback qualifies as a finance lease, you must account for it as though no sale occurred and record it as a failed sale-leaseback. Without a repurchase option, GAAP will likely classify your sale-leaseback as an operating lease, allowing you to record interest and amortization as a single straight-line expense over the lease term.

In summary, a lease’s characterization affects the timing and presentation of expense recognition. As a result, the lease classification may affect financial ratios and operating metrics, such as EBITDA, that sureties, lenders, and investors closely monitor.

Important: A lease’s tax characterization may not necessarily follow its GAAP characterization. Different tax and GAAP treatments can complicate both tax compliance and financial reporting.

Your construction equipment may hold untapped value that you can convert into cash through a sale-leaseback arrangement. However, carefully evaluate the potential drawbacks before moving forward. However, you should do so only under the right circumstances and with full knowledge of the potential drawbacks.