Sale-leaseback and 1031 Exchange Real Estate Investment Strategies

 A sale-leaseback is a financial arrangement in which a business sells a property or asset it owns to an external party (typically a real estate or financial company) and simultaneously enters into a long-term lease agreement to continue using the property or asset. In essence, the business becomes the tenant while the external party becomes the landlord.


I've built many financial models for all size real estate deals, check out these real estate underwriting templates for more  (build and rent, build and sell, acquire/value add and rent, and all kinds of things).

I've had one larger client that had me model a sale leaseback with a few different caveats for a planning exercise.

Here's how a sale-leaseback typically works:

  • Sale of Asset: The business owner sells an asset, often real estate, but it can also be equipment or machinery, to an investor or leasing company. The sale generates immediate cash for the business.
  • Lease Agreement: After the sale, the business enters into a lease agreement with the new owner. This lease can be for a fixed term, often several years, during which the business continues to use the asset.  It's important to negotiate maintenance responsibilities, modifications, and subleasing rights.

Sale-leaseback arrangements can be beneficial for both parties involved and can be used as a financial and strategic tool for businesses. Here are some strategies and advantages associated with sale-leaseback transactions:

  • Access to Capital: The primary benefit for the business is immediate access to cash. This can be used for various purposes, such as funding expansion, paying down debt, or investing in core operations.
  • Asset Optimization: Sale-leaseback allows a business to unlock the value tied up in its owned assets. This can be particularly useful when the company's capital is better deployed in its core business activities rather than tied up in real estate or equipment.
  • Off-Balance Sheet Financing: The leaseback arrangement can help improve the company's balance sheet by reducing assets and corresponding liabilities. This can make the company look more attractive to investors and lenders.
  • Predictable Costs: Long-term lease agreements often come with fixed lease payments, providing cost predictability for the business. This can be especially valuable in a rising interest rate environment when borrowing costs may increase.
  • Asset Management: Sale-leasebacks can be part of an asset management strategy. If the business believes that owning and managing real estate or equipment is not its core competency, it may choose to sell these assets and lease them back to focus on its core operations.
  • Tax Benefits: Depending on the tax laws in a given jurisdiction, a sale-leaseback may have potential tax advantages, such as the ability to deduct lease payments as operating expenses.
  • Exit Strategy: The agreement should include clear terms regarding the end of the lease, such as buyback options or first rights of refusal, giving the company a clear exit strategy.
  • The decision to engage in a sale leaseback should consider market conditions. Selling an asset in a favorable market can maximize the capital received.
  • Investor Relations: Since sale leasebacks can affect a company’s financial statements, it’s important to communicate effectively with investors and stakeholders about the reasons and expected benefits of the transaction.
  • Cost-Benefit Analysis: Companies should perform a thorough cost-benefit analysis to weigh the immediate financial gain against the long-term costs of leasing.

It's important to note that sale-leasebacks should be carefully evaluated and structured to ensure they align with the company's overall financial and strategic objectives. Additionally, the terms and conditions of the lease, including rent escalation clauses and renewal options, should be negotiated to best suit the business's needs and financial stability. Legal and financial advice is often essential when considering a sale-leaseback transaction to ensure that it is a sound and advantageous decision for the business.

A 1031 exchange, also known as a like-kind exchange under Section 1031 of the Internal Revenue Code, is a tax-deferred exchange that allows an individual or business to sell a qualifying investment property and reinvest the proceeds into another like-kind property, deferring capital gains taxes in the process. A 1031 exchange is primarily used for real estate investments. On the other hand, a sale-leaseback involves selling a property and leasing it back, typically as part of a financing or asset management strategy. While both concepts deal with real estate, they serve different purposes and have different tax implications.

Here's how a 1031 exchange and a sale-leaseback differ:


  • 1031 Exchange: The primary purpose of a 1031 exchange is to defer capital gains taxes on the sale of investment or business real estate by reinvesting the proceeds into another like-kind property. It's a tax-deferral strategy to preserve investment capital.
  • Sale-Leaseback: A sale-leaseback is typically used as a financing tool or asset management strategy. It allows a property owner to sell their property and lease it back to continue using it while accessing capital locked in the property.

Tax Treatment:

  • 1031 Exchange: Capital gains taxes are deferred in a 1031 exchange, provided that the seller meets all the IRS requirements for like-kind exchanges. Taxes are eventually paid when the replacement property is sold without another exchange. The basis is going to be the original properties purchase price (not the replacements) plus any improvements less the total depreciation expense taken during the hold period. You may have depreciation recapture if you took depreciation expenses during the holding period and sold the property for a price higher than the original basis. Then, any capital gains taxes apply if the sales proceeds are greater than the original basis.
  • Sale-Leaseback: In a sale-leaseback, capital gains are realized and may be subject to immediate taxation. However, the financial benefits of the transaction, such as improved cash flow and access to capital, can outweigh the tax consequences for some businesses.
Deferring taxes is all about the time value of money, if you can re-invest the gain now and pay taxes later, any gains on that invested capital are icing on the cake.

Reinvestment Requirement:

  • 1031 Exchange: To defer taxes in a 1031 exchange, the seller must reinvest the entire proceeds from the sale into a like-kind property within specific timeframes and follow IRS rules regarding identification and acquisition of replacement properties.
  • Sale-Leaseback: There is no requirement to reinvest the proceeds in another property in a sale-leaseback. Instead, the proceeds can be used for various purposes, such as debt reduction, business expansion, or other investments.

While a 1031 exchange and a sale-leaseback serve different purposes, they can sometimes be related. For example, a property owner might use a 1031 exchange to acquire a new like-kind property, and then, at a later date, decide to enter into a sale-leaseback arrangement with the newly acquired property. In this scenario, the tax-deferral benefits of the 1031 exchange are preserved, and the owner can access capital through the leaseback.

Here's a high-level overview of how it can be done:


First, you would initiate a sale-leaseback transaction, where you sell a property you own to an external party and simultaneously enter into a lease agreement to continue using the property. This generates cash for your business while allowing you to remain in the property as a tenant.

1031 Exchange:

After completing the sale-leaseback, you can potentially use the proceeds from the sale of your property as the "relinquished property" in a 1031 exchange. To do this, you must identify a "replacement property" that meets the IRS's like-kind exchange requirements and complete the exchange within the specified timeframes.

  • Like-Kind Property Requirement: Ensure that the replacement property you identify and acquire through the 1031 exchange qualifies as a "like-kind" property. In a 1031 exchange, the definition of like-kind is relatively broad for real estate, which means you can exchange various types of real property (e.g., commercial for residential).
  • Timing: A 1031 exchange has strict time constraints. You must identify potential replacement properties within 45 days of the sale of your relinquished property and complete the acquisition of the replacement property within 180 days.
  • Qualified Intermediary: Engage a qualified intermediary (QI) to facilitate the 1031 exchange. The QI will hold the proceeds from the sale-leaseback and help ensure that the exchange complies with IRS regulations.
  • No Use of Sale Proceeds: During the 1031 exchange process, you must not personally take control of or use the sale proceeds from the sale-leaseback. The funds should go directly to the QI.
  • Tax Deferral: If you successfully complete the 1031 exchange by acquiring a like-kind replacement property within the specified timeframes, you can defer the capital gains tax that would have been triggered by the sale-leaseback and continue your operations in the new property.

It's crucial to seek guidance from legal and tax professionals experienced in 1031 exchanges and sale-leaseback transactions. These transactions involve complex rules, and the IRS closely scrutinizes them to ensure compliance. Any deviation from the regulations can result in the loss of tax benefits or unexpected tax liabilities.

Additionally, the specifics of your situation and the nature of the properties involved can significantly impact the feasibility and success of combining a sale-leaseback with a 1031 exchange, so a customized approach is essential.

You may also find this cost segregation study template helpful.

It's crucial to consult with tax professionals, legal advisors, and financial experts to evaluate the specific circumstances of a real estate transaction and determine the most appropriate strategies, including whether a 1031 exchange and a sale-leaseback can be combined to achieve desired financial and tax objectives.