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Sale and Leasebacks as an Alternative to Higher State and Local Taxes

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by 24Richie
Tuesday, Dec 14, 2021 - 14:10

Sale and Leasebacks as an Alternative to Higher State and Local Taxes

Before COVID many state and local governments were already in fiscal difficulty. Of particular concern were and still are government pension obligations. In general these shortfalls are the result of state and local government not setting aside enough money to meet pension obligations. Politicians were trying to simultaneously make public employees and taxpaying voters happy.

One effect of the pandemic is that some state and local government tax receipts have been severely reduced. While decisions about reducing staff and services are up to the individual governments there is one solution to the cash problem which gets little consideration. This potential solution is for municipalities to do what are called Sale and Leasebacks. An excellent paper on this was written by Steve Hanke of Johns Hopkins and Stephen J.K. Walters of Loyola University Maryland published in the Journal of Applied Corporate Finance in November 2018. The article is paywalled but an abstract is available here https://onlinelibrary.wiley.com/doi/epdf/10.1111/jacf.12309 

The motivation for this came from the idea that urban revitalization could not be accomplished without cuts in property taxes. Between 1950-1980 nine of the ten most populous cities in the  nation lost population. Cities responded by raising taxes in order to keep services at the same level. Cities kept increasing property taxes and people continued to leave. Between 1950-1975 San Francisco increased its property tax rate 17 times. S.F.’s population fell by 14%.

In 1978 a California voter proposition called Prop 13 capped local property tax rates at 1%. In San Francisco this reduced property taxes by two-thirds.  There were two effects:  1) investors poured capital into residential and commercial property which caused people and jobs to return to the city 2) income to cities dropped as property tax revenue temporally fell.

Four years after the passage of Prop. 13 real estate values in S.F. had increased so much that income from real estate taxes was twice what it was before Prop 13.

But…

The problem when taxes are cut is that this can create a period of several years of fiscal deficits. This is where Sale and Leasebacks come in.

In order to make up for the temporary cash shortfall created by lower taxes cities can sell real estate they own for cash.  These agreements allow the city to lease back the real estate for a period of time and at the end of the agreement the city regains ownership of the property. The advantage to the city is the inflow of cash sufficient to get it through the several years of deficits.

What makes this work is that it takes advantage of tax codes. When the city owned the property there was no property tax receipt. After the sale there are property tax receipts which are a cost to the buyer but the advantage to the buyer is that the property can now be depreciated which is a very large write-off for any entity which would otherwise have significant income tax liabilities.  The fact that the buyer can now take advantage of depreciation makes the rent that a city would pay attractive.

State and local governments own a tremendous amount of physical assets such as real estate and utilities and should look to SLBs to make up the cash shortfall created by the pandemic.

In essence local governments have four choices: borrow money with general obligation bonds, reduce services enough to eliminate deficits, increase taxes and risk reducing revenue if property values fall and income decreases, and SLBs.

Because of their complexity SLBs are best put together by large investment banks which have contact with both governments and wealth holders and an experienced staff with knowledge as to how to correctly put together the documents to comply with federal and state tax codes.

 

Dick Lepre

Senior Loan Advisor

RPM Mortgage

Alamo, CA

NMLS #302379

Web site: http://www.loanmine.com

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If your property is in California apply for a mortgage online on your computer or Smartphone:

https://applynow.rpm-mtg.com/borrower/signup/dicklepre@rpm-mtg.com

 

LendUS, LLC dba RPM Mortgage – NMLS #1938 l Licensed by the Department of Financial Protection and Innovation under the California  Residential Mortgage Lending Act l Equal Housing Opportunity  

 

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