Built-to-Suit Lease Accounting: The ASC 842 Control Test
In a built to suit lease, the landlord builds or redesigns an asset to the tenant's specifications. The tenant leases it once it is ready. Under ASC 842, the accounting turns on one question: does the tenant control the asset while it is being built?
If it does, ASC 842-40-55-5 makes the tenant the accounting owner, and the deal runs through the sale-leaseback guidance. If not, the tenant books a normal lease at commencement. That control test replaced the old ASC 840 "deemed owner" rules. This page walks through the five indicators of control, what each one puts on the books, and how the arrangement ends.
How does build-to-suit lease accounting work under ASC 842?
The starting point is ASC 842-40-55-3. It recognizes that a lease may be signed before the asset exists, and that the asset "may need to be constructed or redesigned for use by the lessee." The tenant may also have to pay toward that construction.
From there the guidance splits into two paths. ASC 842-40-55-5 states: "If the lessee controls the underlying asset being constructed before the commencement date, the transaction is accounted for in accordance with this Subtopic." This Subtopic is 842-40, the sale-leaseback guidance. If the tenant lacks control, the lease follows Subtopic 842-20 like any other lease.
So the first job at contract signing is the control assessment. Get it wrong and the whole balance sheet treatment is wrong, for years. A tenant that controls the asset carries the building during construction, often one it does not legally own.
A tenant that does not control it records no building until commencement. It may still carry prepaid rent and, under ASC 360, improvements it owns itself.
When does a lessee control an asset under construction?
ASC 842-40-55-5 lists five circumstances. "Any one (or more)" of them demonstrates that the lessee controls the asset before commencement. One yes is enough. You do not weigh them against each other.
The list is also not complete. The paragraph says other circumstances, "individually or in combination," may show control too. KPMG's Leases Handbook (Question 9.4.50) suggests one such test: whether the work creates an asset the lessee controls as it is built. KPMG draws that from the over-time test in revenue recognition, ASC 606-10-25-27(b).
Construction financing raises a common question. KPMG's Handbook (Question 9.4.40) answers "By itself, no" on whether a loan to the lessor gives the lessee control. Terms attached to the loan can change that. A right to take the asset if the lessor defaults is one example.
Momentary title is a different matter. Under ASC 842-40-55-1, a lessee that controls an asset before it passes to the lessor is in a sale-leaseback. Sometimes a lessee takes legal title only briefly, for tax or other reasons, before title passes to the lessor. If the lessee never controlled the asset, ASC 842-40-55-2 treats the deal as the lessor's purchase plus a lease.
KPMG's Handbook: Leases (paragraph 9.4.30) says this "flash title" "does not mean a lessee controls the underlying asset before lease commencement." Legal ownership of the asset under construction is different. Under ASC 842-40-55-5(c), legally owning both the land and the building (or a non-real-estate asset such as a ship) demonstrates control on its own.
Checklist: the five control indicators in ASC 842-40-55-5
Run every build-to-suit contract through this table at signing, and again if a term such as a purchase option or a default right becomes exercisable. KPMG's Handbook (Questions 9.4.10 and 9.4.40) explains that control can pass at that later point. A yes on any of the five rows makes the tenant the accounting owner during construction.
| Question to ask | ASC paragraph | What a yes means on the books |
|---|---|---|
| Can the tenant obtain the partly built asset at any point during construction, for example by making a payment to the landlord? | 842-40-55-5(a) | Tenant controls the asset. It carries construction in progress and a financial liability for landlord-funded costs. |
| Does the landlord have an enforceable right to payment for work to date, and does the asset have no alternative use to the landlord? | 842-40-55-5(b), with 842-10-55-7 on alternative use | Tenant controls the asset. Judge alternative use on the asset that will ultimately be leased. |
| Does the tenant legally own both the land and the building under construction, or the non-real-estate asset (a ship, an airplane)? | 842-40-55-5(c) | Tenant controls the asset. Same entries as row one. |
| Does the tenant own or control the land, and has it not leased the land, before construction begins, to the landlord or another unrelated party for substantially all of the building's economic life (renewal options included)? | 842-40-55-5(d) | Tenant controls the asset. A land transfer to the landlord that fails the sale test under 842-40-25-1 through 25-3 still counts as tenant control of the land. |
| Does the tenant lease the land for substantially all of the building's economic life (counting its own renewal options), and has it not subleased the land, before construction begins, to the landlord or another unrelated party for substantially all of that life (renewal options included)? | 842-40-55-5(e) | Tenant controls the asset. Count the sublease's renewal options when you test the sublease. |
Two limits sit outside the table:
- The list is "not all inclusive." Under the closing text of ASC 842-40-55-5, other facts can show control, so a no on all five rows does not end the analysis.
- An indemnity for preexisting environmental contamination is not control on its own, "regardless of the likelihood of loss resulting from the indemnity" (ASC 842-40-55-7).
Worked illustration: does a ground lease make the tenant the owner?
Rows four and five catch most real estate deals, so here is one with every input stated. The tenant leases a parcel from an unrelated landowner. The ground lease runs 15 years, with three 10-year tenant renewal options. The ground lease has already commenced.
A developer will build a warehouse on it with an expected economic life of 40 years.
Test row five. The ground lease with the tenant's options covers 15 + (3 × 10) = 45 years. That exceeds the warehouse's 40-year life, so the first condition is met.
Before construction begins, the tenant subleases the land to the developer for 15 years. The developer gets one 5-year renewal option. That is 15 + 5 = 20 years, half of the 40-year life.
The sublease does not give the developer the land for substantially all of the warehouse's life. Under ASC 842-40-55-5(e), the tenant controls the warehouse while it is built. ASC 842-40-55-5 sets no percentage for "substantially all of the economic life," so a closer case takes judgment. This one is not close.
Now change one fact. Before construction begins, and with the same ground lease in place, give the developer a sublease of 15 years with three 10-year renewal options, 45 years in total. The developer can now use the land for the warehouse's whole 40-year life, so row five no longer applies. The tenant would then work through the remaining rows before concluding.
What does the tenant record during construction if it controls the asset?
The tenant books the project as its own asset. PwC's Viewpoint Leases guide, section 6.3.4.3, says the lessee should account for it "similar to any other asset under construction that it controls." It adds: "Any costs of construction paid for by the lessor should be recognized by the lessee as a financial liability."
On the books, construction in progress grows each month as the landlord spends. A matching financial liability grows with it. Neither is a right-of-use asset or a lease liability yet.
Sometimes the landlord started work before the contract. KPMG (Question 9.4.70) believes the tenant then records that work at its current fair value, with an equal liability.
Interest on the construction liability may qualify for capitalization under ASC 835-20. Our article on capitalized interest under ASC 835-20 covers when that applies.
How is a build-to-suit different from a sale-leaseback?
A controlled build-to-suit becomes a sale-leaseback when construction ends. KPMG's Handbook (paragraph 9.4.60) puts it this way: the transaction "is a sale-leaseback transaction when construction is complete and the asset is available for use (usually at lease commencement)." In effect, the tenant is treated as selling the finished asset to the landlord and leasing it back.
The sale test then decides the outcome. ASC 842-40-25-1 applies Topic 606 to judge whether control passes to the landlord. ASC 842-40-25-2 says there is no sale if the leaseback would be a finance lease, or a sales-type lease (the landlord's side). Under ASC 842-40-25-3, a tenant repurchase option also blocks a sale, unless it is priced at fair value and similar assets are readily available.
If the transfer is a sale, ASC 842-40-25-4 has the tenant derecognize the asset and account for the lease under Subtopic 842-20. Our article on sale-leaseback gain recognition covers that gain. If the transfer fails, ASC 842-40-25-5 says the tenant "shall not derecognize the transferred asset." The construction liability then continues as a financing.
A build-to-suit the tenant never controls is not a sale-leaseback at all. The Codification's Example 3, Case A, concludes that such an arrangement "is not within the scope of this Subtopic" (ASC 842-40-55-42). Control during construction is the gate to Subtopic 842-40.
How are tenant payments before commencement treated without control?
When the tenant does not control the asset, the lease starts at commencement in the normal way. Our article on lease inception vs commencement date explains why that date matters. Payments made before then still need a home.
ASC 842-40-55-4 sends costs relating to the construction or design of the asset to other Topics, such as Topic 330 or Topic 360. It excludes payments for the right to use the asset: those are lease payments "regardless of the timing of those payments or the form of those payments."
The Codification's Example 3, Case A (ASC 842-40-55-42), shows where the line falls for a tenant without control. Take construction or design costs the tenant incurs, such as architectural services for the building's specifications. They are lease payments "unless the costs are for goods or services provided to Lessee," in which case other Topics apply.
In practice the question is what the payment buys. Money the lease requires the tenant to put toward the landlord's building, such as a share of cost overruns or construction materials, is prepaid rent. At commencement it goes into the right-of-use asset under ASC 842-20-30-5(b). Improvements the tenant itself owns are its own asset under ASC 360.
PwC's Viewpoint Leases guide (Example LG 6-7) and Deloitte's Roadmap: Leasing (Examples 11-2 and 11-3) work through both cases.
Landlord-funded fit-out is a separate question. Our article on tenant improvement allowance accounting covers those incentives.
What changed from the ASC 840 build-to-suit rules?
ASC 840 used a risk test. KPMG's Handbook (paragraphs 9.4.100–9.4.110) explains that the lessee was the owner during construction if it took on substantially all of the construction-period risks. Certain activities, listed as prohibited involvement, also made it the owner. Paying for cost overruns and taking title during construction were among them.
ASC 842 dropped that approach. In the words of the executive summary in KPMG's Handbook (chapter 1), Topic 842 "does not consider exposure to construction period risks, nor does it explicitly prohibit certain activities." As a result, KPMG adds, "some different accounting outcomes result" compared with ASC 840.
The same summary notes that transition led "many entities" to derecognize build-to-suit assets and liabilities that remained on the balance sheet after construction ended under ASC 840.
For a private company, the practical point is simple. An ASC 840 conclusion does not carry over to a new contract. Each new build-to-suit is tested against the ASC 842-40-55-5 indicators.
Frequently asked questions
Is a build-to-suit lease the same as a sale-leaseback?
Not always. A build-to-suit lease becomes a sale-leaseback only when the tenant controls the asset under construction before commencement (ASC 842-40-55-5). If the tenant never controls it, the arrangement is an ordinary lease that starts at commencement, and Subtopic 842-40 does not apply.
Does an environmental indemnity make the tenant the owner of a building under construction?
Not on its own. ASC 842-40-55-7 says an indemnity for preexisting environmental contamination does not, by itself, mean the lessee controlled the asset before the lease commenced. That holds whatever the likelihood of loss under the indemnity.
Does lending construction money to the landlord give the tenant control?
Not by itself, in KPMG's view. Its Handbook: Leases (Question 9.4.40) says a loan to the lessor, in isolation, does not meet any of the five indicators. Terms attached to the loan can change that, such as a right to take the asset if the lessor defaults.
Sources and further reading
- KPMG, Handbook: Leases, chapter 1 (Executive summary); section 9.4, paragraphs 9.4.30, 9.4.60 and 9.4.100–9.4.110; Questions 9.4.10, 9.4.40, 9.4.50 and 9.4.70
- PwC Viewpoint, Leases guide, 6.3: Determining whether a sale has occurred (section 6.3.4.3 and Example LG 6-7)
- Deloitte DART, Roadmap: Leasing, 11.3: Lessee's involvement in construction before lease commencement (build-to-suit arrangements) (Examples 11-2 and 11-3)
- ASC 842 compliance guide for construction companies
Tour of iLeasePro
Schedule a Demo
Check Out Knowledge Base
