Rent is deductible, but the tax on the gain is paid at completion out of the proceeds, and that changes the after-tax cost more than the deduction does.
Less than it looks. Rent is deductible, so the usual shortcut takes the pre-tax cost of a leaseback and multiplies it by one minus the tax rate: 8.13 per cent becomes 6.10. Count the tax paid on the gain at completion, the tax depreciation the seller gives up and the tax it would have paid on the building one day anyway, and the after-tax cost on an illustrative 50,000,000 deal is 7.39 per cent, 129 basis points above the shortcut and 326 above an after-tax mortgage.
Worked in full in Sale and Leaseback by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
The question a CFO asks is not whether rent is deductible. It is what the cash raised by the sale costs once the tax authority has taken its share at both ends. That is an internal rate of return on the seller's incremental cash flows, after tax, measured against simply keeping the building.
| Input | Value |
|---|---|
| Sale price | 50,000,000 |
| Selling costs | 1.5% |
| Tax base of the building | 20,000,000 |
| Corporate tax rate | 25% |
| Initial rent (6.0% of price) | 3,000,000 |
| Fixed annual uplift | 2.0% |
| Lease term | 20 years |
| Tax depreciation the owner claims now | 3% of 12,000,000 |
| Building value growth | 2.0% a year |
Tax is charged on the price less selling costs less the tax base, not the book value. The gain is 50,000,000 less 750,000 less 20,000,000, or 29,250,000. At 25 per cent that is 7,312,500, due on the sale (taken at completion here), so the seller banks 41,937,500, 83.9 per cent of the price. How the rest of the proceeds leak away, to a mortgage and a rent deposit, is worked in how much cash a sale and leaseback actually raises.
Each year the seller pays rent and deducts it. The first year's 3,000,000 costs 2,250,000 after tax, rising with the uplift to 4,370,434 before tax in year 20. But the owner was also claiming 360,000 a year of tax depreciation on the building, worth 90,000 a year at 25 per cent. That relief goes with the building, so it is a cost of the leaseback every year of the lease.
At the end of the lease the buyer owns a building that, at 2.0 per cent growth, is worth 74,297,370. Had the seller kept it, its tax base would by then be 12,800,000 after twenty years of depreciation, and selling it would have cost 15,374,342 of tax. What the leaseback gives up is therefore 58,923,027 after tax, not the gross value.
After-tax cost = IRR of: net proceeds after tax at year 0, minus rent × (1 − t) and lost depreciation relief each year, minus the after-tax residual in year 20
In Excel, with year 0 in B2 and years 1 to 20 below it: =IRR(B2:B22). Build the column; do not adjust a pre-tax rate.
| Measure | Rate |
|---|---|
| Pre-tax cost of the leaseback (IRR) | 8.13% |
| Shortcut: 8.13% × (1 − 25%) | 6.10% |
| After-tax cost, built from the cash flows | 7.39% |
| Same, ignoring the lost depreciation | 7.29% |
| Mortgage at 5.5%, after tax | 4.12% |
The shortcut would be right only if the whole transaction were taxed symmetrically over time. It is not. Rent relief arrives slowly over twenty years; the tax on the gain is paid at once, out of the very proceeds the deal exists to raise. A seller with a low tax base effectively prepays two decades of tax at the start, which is why the after-tax cost sits much closer to the pre-tax one than the deductibility of rent suggests. Why the pre-tax figure is already well above a mortgage is set out in whether a sale and leaseback is cheaper than a mortgage.
The tax base decides most of the answer, because it sets the bill on day one.
| Tax base | Tax on the gain | Net proceeds | After-tax cost |
|---|---|---|---|
| 5,000,000 | 11,062,500 | 38,187,500 | 7.95% |
| 20,000,000 | 7,312,500 | 41,937,500 | 7.39% |
| 35,000,000 | 3,562,500 | 45,687,500 | 6.85% |
| 49,250,000 | 0 | 49,250,000 | 6.41% |
An old building with a tax base of 5,000,000 costs 7.95 per cent after tax, barely below its pre-tax cost: the tax saving on rent is almost entirely returned at completion. Only when there is no gain to tax does the after-tax cost approach the shortcut, and even then it stays above it, because the depreciation relief is still lost and the residual given up is valued net of tax the owner would only have paid at the very end.
| Tax rate | Net proceeds | Pre-tax cost | After-tax cost |
|---|---|---|---|
| 0% | 49,250,000 | 8.13% | 8.13% |
| 15% | 44,862,500 | 8.13% | 7.72% |
| 25% | 41,937,500 | 8.13% | 7.39% |
| 30% | 40,475,000 | 8.13% | 7.20% |
Five extra points of tax rate take only 19 basis points off the cost. Higher tax makes the rent deduction worth more and the exit charge larger in the same breath, so the two largely cancel.
Tax rules on property disposals, depreciation and rent deductibility differ by country and by entity, and some regimes allow the gain to be rolled over or deferred. The figures here are illustrative and are not tax advice.
To rerun this with your own price, rent and tax position, start from the free workbook for this case, or the sale-leaseback model template.
Generally yes, as an operating expense of the tenant, which is why leasebacks are marketed as tax efficient. But the seller also pays tax on the gain at completion and loses its tax depreciation on the building. On an illustrative 50,000,000 sale with a 20,000,000 tax base, the tax on the gain is 7,312,500 and the after-tax cost of the cash raised is 7.39 per cent.
When the building has a high tax base, so there is little or no gain to tax on the sale. In the illustrative case the after-tax cost is 6.41 per cent with no taxable gain and 7.95 per cent with a 5,000,000 tax base, where almost all the value of the rent deduction is handed back at completion.
Only slightly. A higher rate makes each rent deduction worth more but also raises the tax on the gain and on the residual. In the illustrative case, moving from 25 to 30 per cent tax lowers the after-tax cost from 7.39 to 7.20 per cent, 19 basis points.
This article is one calculation from Sale and Leaseback. The book takes the same case from first principles to the decision, chapter by chapter, and every figure it prints is a live formula in the free companion workbooks.
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