Introduction
In August 2023, Big Lots sold its Apple Valley, California, distribution center and 23 of its owned stores to a single buyer for $305.7 million, and leased every property back for an initial 20 years. The discount retailer used the cash to pay off a lease financing on the distribution center and repay borrowings under its credit facility. In its income statement, the deal produced a gain on sale of real estate, net of related expenses, of $204.7 million in the third quarter, enough to cut the year's operating loss by more than a third. Thirteen months later, in September 2024, Big Lots filed for Chapter 11.
A sale-leaseback lets a company convert property it owns into cash without giving up the use of it. The accounting has to decide whether the transaction is what it claims to be, a sale followed by a lease, or a loan secured on the property and dressed up as one. The answer determines whether a gain appears, whether the asset stays on the balance sheet and whether the cash raised counts as investing proceeds or borrowing.
When a Sale-Leaseback Counts as a Sale
Under Accounting Standards Codification (ASC) 842-40, the seller-lessee first asks whether the transfer of the asset would be a sale under the revenue standard, applying the control principles covered in revenue recognition under ASC 606. Two features of a leaseback prevent sale treatment:
- A finance leaseback: if the leaseback is classified as a finance lease, the seller has in substance kept control of the asset, so no sale occurs.
- A repurchase option: an option for the seller-lessee to buy the asset back prevents a sale, unless the exercise price is the asset's fair value at the time and alternative assets, substantially the same, are readily available in the market. Real estate never meets that condition, because no two properties occupy the same location, so any purchase option on real estate causes a failed sale.
Deloitte's guide to sale-and-leaseback recognition and measurement sets out the consequences of each answer, and the five tests that decide whether a leaseback is a finance lease are covered in operating vs finance lease classification. A right of first refusal, which lets the seller match a third party's offer, does not by itself prevent a sale; Big Lots' leases include one beginning after the fifth year.
- Failed sale-leaseback
A sale-leaseback that does not qualify as a sale under ASC 842-40, typically because the leaseback is a finance lease or the seller-lessee holds a repurchase option. The seller keeps the asset on its balance sheet, continues to depreciate it and records the cash received as a financial liability.
Accounting for a Successful Sale
When the transaction qualifies as a sale, the seller removes the asset from its balance sheet, recognizes the full gain or loss at once and accounts for the leaseback like any other lease. The previous standard, ASC 840, generally required gains to be deferred and recognized over the leaseback term; ASC 842 removed that deferral, which made sale-leasebacks more attractive as a way to report a gain.
Suppose a company owns a building with a carrying amount of $400 and a fair value of $1,000. It sells the building for $1,000 and leases it back for ten years under an operating lease, with payments whose present value is $600. Ignoring tax:
The full $600 gain appears in operating income, the $1,000 of proceeds is an investing inflow, and the leaseback adds a right-of-use asset and lease liability of $600, measured as described in lease accounting under ASC 842. From then on, the company records straight-line rent in operating expenses instead of depreciation on the building.
Off-Market Prices
Buyer and seller can trade price against rent: a lower sale price in return for lower rent, or a higher price in return for higher rent. ASC 842 requires the seller to adjust for terms that are not at market, measured by comparing the sale price with the asset's fair value or the leaseback payments with market rent. A price below fair value is treated as prepaid rent, added to the right-of-use asset; a price above fair value is treated as additional financing from the buyer-lessor, a liability separate from the lease. Without the adjustment, a seller could raise its gain by inflating the price and paying it back through higher rent.
Big Lots' transaction shows both adjustments. Comparing the cash received for each property with its fair value, the company recorded $36.5 million of prepaid rent for properties sold below market, which raised its aggregate net proceeds to $332.1 million, and $0.6 million of financing liability for properties sold above market.
Accounting for a Failed Sale
When the transfer is not a sale, nothing is sold for accounting purposes. The seller keeps the asset on its balance sheet and keeps depreciating it, records the cash received as a financial liability, and splits each payment to the buyer-lessor between interest expense and repayment of that liability. No gain is recognized, and the cash received is a financing inflow rather than an investing one.
| Item | Successful sale | Failed sale |
|---|---|---|
| Asset sold | Removed from the balance sheet | Stays on the balance sheet and keeps being depreciated |
| Cash received | Investing inflow | Financing inflow |
| Gain or loss | Recognized in full at the sale date | None |
| New liability | Lease liability for the leaseback | Financial liability for the cash received |
| Ongoing cost | Lease cost, usually straight-line rent in operating expenses | Depreciation plus interest expense |
Because the asset never leaves the seller's books in a failed sale, the transaction can still become a sale later: if the repurchase option lapses or the leaseback terms change so that the conditions are met, the seller recognizes the sale at that point.
What a Sale-Leaseback Does to the Numbers
For the seller, a successful sale-leaseback swaps an owned asset for a lease. Cash rises, the property leaves the balance sheet and a lease liability takes its place. The cost of using the property changes from depreciation, which is excluded from earnings before interest, taxes, depreciation and amortization (EBITDA), to rent, which is not. EBITDA therefore falls by the rent for as long as the lease runs, even though the business is unchanged. The one-off gain inflates operating income and net income in the year of the sale, but it is not part of EBITDA as bankers measure it, and it belongs with the other items covered in one-time items: restructuring, impairments and gains.
Big Lots' 2023 annual report shows the trade-off. At commencement, the company recorded $224.2 million of operating lease liabilities and $260.6 million of right-of-use assets, including the prepaid rent, using a weighted average discount rate of 10.6%. Initial annual payments to the buyer-lessor were about $24 million, rising 2% a year, with straight-line rent expense of about $30 million a year. In return for $332.1 million of proceeds and a large one-off gain, the company committed to two decades of rising rent on properties it had owned.
The cash flow statement tells the same story. The proceeds sit in investing activities, as proceeds from the sale of property, not in operating cash flow. For a healthy company, a sale-leaseback can be a sensible way to release capital tied up in real estate and redeploy it at higher returns. For a struggling one, it can be a sign that cheaper sources of funding have run out, and the 10.6% discount rate on Big Lots' new leases, which reflects the company's own incremental borrowing rate on a secured basis and sits far above what an investment-grade borrower would pay, suggests which case applied. Either way, the right comparison is between the proceeds and the present value of the rent taken on in exchange, and whether a lender or rating agency counts the new lease liability as debt.
