LILO Comes Up One Leg Short

By Schnee, Edward J. | Journal of Accountancy, August 2008 | Go to article overview

LILO Comes Up One Leg Short


Schnee, Edward J., Journal of Accountancy


The Fourth Circuit Court of Appeals held that a LILO (lease in, lease out) transaction by banking company BB&T Corp. was not a genuine leasehold interest but only a circular transfer of funds. In so ruling, the Fourth Circuit upheld a district court's denial of deductions arising from the deal.

At the recommendation of a LILO promoter, BB&T in 1997 leased an interest in wood pulp manufacturing equipment from a Swedish cooperative for 36 years. The bank simultaneously leased the equipment back to the cooperative for 15.5 years. At the end of the sublease, the cooperative could repurchase the remaining lease years. Alternatively, BB&T could extend its lease for another 13.3 years or lease the equipment to another party. In effect, the cooperative continued to use the equipment and had significant incentives to reacquire all rights at the end of the sublease. The deal was partially financed by a loan secured and repaid by the rent payments, resulting in a $68 million intrabank transfer in which no money changed hands. On its 1997 tax return, BB&T reported a deduction for rent, interest and fees, net of sublease income, of $9.4 million, which the IRS disallowed. LILOs, like other tax shelter transactions, are usually evaluated under the economic substance doctrine. Since the litigation was for summary judgment, the court decided to analyze the lease and loan separately, using the form-versus-substance doctrine instead of the economic substance doctrine.

The analysis of the lease was based on the Supreme Court's decision in Frank Lyon Co. (41 AFTR2d 78-1142) that a lease will be honored if the lessor retains significant and genuine attributes of the traditional lessor status. …

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