With tax day quickly approaching, we’d like to address a greatly misunderstood area of corporate real estate leasing – capital leases versus operating leases.

In the accounting world, payments for leased corporate assets must be accounted for correctly, and the Financial Accounting Standards Board (FASB) has developed criteria to help you as a manager identify your type of lease. What it comes down to is whether the risks and benefits of ownership rest upon the owner or the lessee:

Capital Lease – Assets appear on statements as if they had been purchased, so the rental payments are treated as interest on a loan taken out to pay for them. The asset (and its accompanying liabilities) is capitalized either by recognizing the present value of the minimum lease payments or the value of the leased assets – whichever is lower. The leased asset is depreciated in the same way as if they had been purchased by the company while its associated liabilities decrease as the rent is paid.

Operating Lease – Payments are simply expensed as they are made because rent is treated as a straightforward expense. The leased asset itself (and associated liabilities) is not recognized.

Until the FASB established its legislation in the 1970s, leasing assets was a common way for companies to avoid declaring their obligations in financial reporting. They only had to disclose leases in statement footnotes, rather than record them as liabilities and so leasing assets was essentially a means of financing a company off the balance sheet. But that changed in 1976, when the FASB issued “Statement no. 13, Accounting for Leases,” which established four questions that would determine whether a lease should be defined as operating or capital:

1.     Is ownership of the asset transferred to the lessee during the term of lease?

2.     Can the lessee buy the asset at a nominal price – $1, for example – when the lease expires (the “bargain purchase option”)?

3.     Will the asset be leased for at least 75 percent of its economic life?

4.     Is the present value of the minimum lease payments at least 90 percent of the value of the asset?

If the answer to all these questions is “no,” then the agreement should be treated as an operating lease. If the answer to any of the questions is “yes,” it is regarded as a capital lease.

Questions? Feel free to contact Omni Realty Group, 717-657-5833, ext. 3 (office), 717-991-6384 (mobile) or mkushner@omnirealtygroup.com.

Dear Property Owners:

Q: What two events are undesirable yet inevitable?
A: (1) death, (2) receiving your annual property tax bills

There’s not much you can do about your mortality, but there is a way to lower your tax bills. As a property owner in Pennsylvania, you have an annual opportunity to reduce your tax bill, and tax bills for years to come, by appealing your property’s assessed value. It’s called a property tax assessment appeal. Simple enough, right? To be successful in a property tax assessment appeal, you just need to know a few basics for filing in Pennsylvania. Did we mention that for many of you the deadline to do so is Aug. 1? Let’s get started.

Step #1: Tax Bill Breakdown
When you get your tax bill, you’ll see your property’s assessed value, which is the basis for municipal, school district and county property taxes. What you owe annually (tax liability) is determined by multiplying the combined tax rate of the three taxing authorities (the millage) by your assessed value, then dividing by 1,000. Obviously, the lower your assessed value, the lower your annual tax liability will be.

Step #2: Calculating Assessed Value
To keep a fair assessed value, your county establishes a “base year,” the year of the most recent countywide assessment, and applies a “common level ratio,” a percentage determined by the State Tax Equalization Board (STEB). Find your county’s common level ratio on STEB’s Web site, www.steb.state.pa.us. Then multiply your common level ratio by your property’s current fair market value to determine your assessed value.

Step #3: Filing an Appeal
To challenge your property’s assessed value, you can file a property tax assessment appeal with your county’s tax assessment appeals board. The appeal must be filed before the deadline, which in most Southcentral Pennsylvania counties is either Aug. 1 or Sept. 1. Make a note in your calendar so you don’t miss these.

Step #4: Supporting Your Case
After your appeal is filed, a hearing is held before the county’s assessment appeals board, where you have the chance to present evidence regarding the value of your property. This can include testimony from you or your real estate appraiser, a written appraisal report and sale prices of similar properties.

Step #5: Reviewing the Outcome
Following the hearing, the board mails in its decision – the new assessed value for your property. Just beware that this could either be an increase or a decrease, so you should consider your chances for a decrease before you spend the time and money to file. If you’re unhappy with the board’s decision, you still have a chance to appeal it to your county’s Court of Common Pleas, and from there to the Commonwealth Court of Pennsylvania.

If you have any questions, feel free to contact us: Ronald M. Lucas, Esq., 717-255-7352, roml@stevenslee.com, and David J. Tshudy, Esq., 717-255-7381, djt@stevenslee.com. We concentrate our practices in real estate matters at Stevens & Lee, and work side-by-side with Omni Realty Group.

Best,

Ronald M. Lucas, Esq. & David J. Tshudy, Esq.
Stevens & Lee
For Omni Realty Group

Note: This column is informational and does not constitute legal advice. Readers must not rely on this column in making decisions and should instead seek professional advice.

Just like you have a checklist for real estate that fits your investing or business needs, a bank has a checklist for loan analysis. Simply put, it’s known as the 5 Cs of credit: character, capacity, capital, collateral and conditions. These items are what a bank looks at in making an approval decision. When one of the Cs is lacking, like the overall conditions of the real estate market and economy, it makes the importance of the other Cs that much greater.

Your capacity to repay the loan depends on the property’s cash flow – either your business income or the rent received from tenants. You should aim for a 1.20x debt coverage ratio, meaning that for every $1 in loan payments, your property or business needs to generate $1.20 in cash flow.

A bank will also look at the ability to resell the property at an amount that at least covers the loan. The value of this collateral is determined primarily by comparable sales in the market or the income stream of the property. For income-producing properties, value can be estimated based on a 10% cap rate.

To help protect against declines in value and limit a bank’s risk, as a borrower you are required to put capital into the purchase of real estate. For most types of properties that means a 20% down payment.

Take a look at this example that brings together the 5 Cs: A three-unit office property is listed for sale at $200,000. The total leases (for all three units) provide rental income of $2,750 per month.

The right combination of capacity (1.20x debt coverage ratio), collateral (a value of $201,500 that is similar to the $200,000 purchase price) and capital (20% down) make a solid deal for an investor and a bank. Don’t forget to add your character to the equation – your credit history can make or break the deal.

If you have any questions, feel free to contact Amy Richmond, vice president and commercial loan manager for Metro Bank, at 717-412-6641. Metro Bank works side-by-side with Omni Realty Group.