One trasaction cures many problems and may be the solution for you. That transaction is the often neglected, and little understood, sale-leaseback.

Are you concerned about getting the profits out of your drilling or drilling equipment business without paying the double-taxation dividends are subjected to, once at the corporate level and again when included on your personal tax return? Afraid of incurring the penalty tax underpaid Internal Revenue Service auditors often impose on the "excessive compensation" of many drilling-related business owners?

Or, perhaps your drilling business could profit from an infusion of badly-needed cash. Are you reluctant to invest additional money in your business? Are the tax benefits from the business wasted because of the operation's low or nonexistent profits - and its low tax bracket?

One transaction cures many problems and may be the solution for you. That transaction is the often neglected, and little understood, sale-leaseback.

This one-transaction-cures-all, all-purpose solution involves the sale-leaseback of assets of your business. At its most basic, your drilling business sells its assets, the building that houses the operation, equipment used in the operation or even the rig that is the business. In return, the business receives an infusion of working capital. The buyer of those assets, usually using borrowed funds, is often the operation's owner or principal shareholder - you.

At Its Most Basic

When the owner or principal shareholders of a drilling or drilling equipment business owns assets of the operation, the business pays fully tax-deductible lease payments for the right to use those assets in its operation. An unprofitable drilling business is exchanging depreciable equipment or its building for badly needed capital and immediate deductions for the lease payments it is required to make.

The new owner of that equipment, whether the business's owner, chief shareholder or, perhaps, a trust established for benefit of the owner's children, will receive periodic lease payments. Thus, with one transaction, the owner has found a way to get money from the business without the double-tax bite imposed on dividends or fear of excessive compensation penalties the IRS levies where they feel the operation's profits may be paid out as compensation.

Those lease payments are, of course, taxable income to the recipient. Fortunately, tax deductions offset much of that income before it reaches the recipient's bottom-line taxable income.

Depreciation write-offs or deductions cost the owner of those assets nothing out-of-pocket. Somewhere down the road, those depreciation deductions will have to be paid back or recovered, usually as ordinary income, but that is at some distant date.

The owner or owners of drilling business equipment and assets are also entitled to deductions for expense of borrowing money used to purchase them. Additional tax deductions such as management fees, maintenance, insurance and the like, further reduce the tax bill on lease payment received from the drilling operation.

As a result of a sale-leaseback you, the owner, are receiving a steady-stream of lease payments that, unlike dividends, are tax deductible by the business. Plus, as owner of those assets or equipment, you are entitled to take advantage of all tax deductions associated with it.

Except where assets of the drilling business are already subject to restrictions imposed by lenders or other investors, you, the owner of those assets are enjoying tax write-offs that might not fully benefit the drilling business entity with its small or nonexistent profits and correspondingly lower tax bracket.

Sales-Leasebacks, The Mechanics

Our tax rules are quite clear regarding sales of any depreciable asset between so-called "related" taxpayers.

Capital gains treatment is denied when depreciable property is sold or exchanged between related taxpayers. This rule covers sales or exchanges between a person and all entities controlled by that person and between a taxpayer and any trust in which that taxpayer or spouse is a beneficiary unless that beneficiary interest is a remote contingent interest.

Similarly, the tax rules also deny losses arising from transactions between related persons. In most situations, a loss from sale or exchange of property is not allowed when sale or exchange is between:

• Members of a family (brothers, sisters, spouse, ancestor or lineal descendent;

• An individual and a corporation if the individual owns (directly or indirectly) more than 50% in value of the outstanding stock;

• A grantor and a fiduciary of any trust;

• A fiduciary of a trust and a corporation more than 50% in value of the outstanding stock of which is directly or indirectly owned by or for the trust or a grantor of the trust;

• A corporation and a partnership if the same persons own (a) more than 50 percent in value of the outstanding stock of the corporation and (b) more than 50% of the capital interest or profits interest in the partnership;

• An S corporation and another S corporation if the same persons own more than 50% in value of the outstanding stock of each corporation; or

• An S corporation and a 'C' corporation if the same persons own more than 50% in value of the outstanding stock of each corporation.

  Any business selling its assets to the owner or principal shareholder may run afoul of the restrictions preventing capital gain treatment for proceeds from those sales. However, only your accountant or banker can advise you whether that restriction applies and, if so, its impact on the transaction.
  
  

  Benefiting From Sale-Leaseback

  It should be obvious that the sale-leaseback of your drilling business assets, equipment or building can cure any number of problems facing you and the business. However, complexity of the rules, requirement that the transaction be conducted at "arm's length," have a bona fide economic purpose rather than mere tax avoidance and be properly structured as a "sale" and subsequent "lease" require professional assistance.