Build-to-Suit Leases under the New Lease Standard ASC 842
It is not unusual for a lessee to be involved with a developer to construct an asset based on the lessee’s specifications prior to the lease commencement date. These type of arrangements are known as a build-to-suit leases. For accounting purposes, if the lessee controls the asset during the construction period before the lease commencement date, it would be deemed to be the owner of the asset. When the construction is completed, the lessee would then apply the sale and leaseback guidance.
ASC 842 makes significant changes to how a lessee would determine whether its involvement in the construction of the asset is subject to sale and leaseback accounting. Under legacy U.S. GAAP (ASC 840), the lessee focuses on whether the lessee has substantially all of the construction-period risk to determine if it is the accounting owner of an asset under construction. However, ASC 842 changes the focus to whether the lessee controls the asset being constructed.
Under ASC 842-40-55-5, a lessee controls the underlying asset being constructed before the commencement date if any one (or more) of the following criteria exists:
- The lessee has the right to obtain the partially constructed underlying asset at any point during the construction period—for example, by making a payment to the lessor;
- The lessor has an enforceable right to payment for its performance to date, and the asset does not have an alternative use to the owner-lessor;
- The lessee legally owns either: (a) both the land and the property improvements that are under construction or (b) the non-real estate asset that is under construction;
- The lessee controls the land that property improvements will be constructed on and does not lease the land to the lessor—or another unrelated third party—before construction starts for a period (including renewals) that is for substantially all of the economic life of the property improvements; and
- The lessee is leasing the land that property improvements will be constructed on for a period (including lessee renewal options) that is for substantially all of the economic life of the property improvements, and does not sublease the land to the lessor—or another unrelated third party—before construction starts for a period (including renewals) that is substantially all of the economic life of the property’s improvements.
Under both ASC 842 and 840 when a lessee is the deemed owner of the asset during construction, it must recognize construction-in-progress in accordance with ASC 360, Property, Plant and Equipment as if it is the party responsible for the construction costs, with a deemed loan (financing obligation) from the lessor, as construction progresses. The lessee would then apply the sale and leaseback guidance when construction is completed.
Under both ASC 842 and 840, when the lessee is not the accounting owner of the asset during construction, there is no deemed loan from the lessor and it would not have to apply the sale and leaseback guidance when construction is completed. As a result, any payments made for the right to use the underlying asset are lease payments, regardless of the timing or form of those payments. Costs incurred by the lessee that relate specifically to construction or design of an asset that are not payments for the use of an asset to be leased are recognized in accordance with ASC 360.
ASC 842 has significantly changed the guidance in determining whether the lessee is the accounting owner of the asset under construction in a built-to-suit arrangement compared to ASC 840. If a company is not considered the accounting owner there is no sale and leaseback guidance to follow when the construction is completed.