Medical Office Building Lease Accounting for Health Systems
Medical office building lease accounting depends on which side of the lease the health system sits. Leasing campus land to a developer makes it a lessor. Renting space in the finished building makes it a lessee. Selling a building and renting it back makes it a seller-lessee, and renting suites to independent physicians makes it a sublessor.
This page covers the owner, seller and landlord side of a medical office building (MOB). The hospital as a tenant, with its discount rates and leasehold improvements, is on the hospital real estate leases page. The full healthcare picture is in the healthcare lease accounting guide.
Which role does the health system play in each MOB structure?
Start every MOB arrangement by naming the system's role. The role decides the subtopic. ASC 842-20 covers lessees, ASC 842-30 covers lessors, and ASC 842-40 covers sale and leaseback transactions. If the terms themselves are fuzzy, the lessee vs lessor page sets them out.
| Structure | System's role | What it recognizes on day one | Income or expense pattern | ASC paragraphs |
|---|---|---|---|---|
| Ground lease of campus land to a developer | Lessor of land | No new asset if operating; the land stays on its books | Straight-line lease income | 842-10-25-2, 842-10-25-3, 842-30-25-11, 842-30-35-6 |
| Leasing space back in the developer's building | Lessee | Right-of-use asset and lease liability | Single straight-line cost (operating) or interest plus amortization (finance) | 842-20-25-1, 842-20-30-1, 842-40-55-5 |
| Sale-leaseback of an existing MOB | Seller-lessee | If a sale: sale price in, building out, leaseback recognized. If not: building stays, cash received is a financial liability | Gain or loss at sale, then lease cost; or interest on the financing | 842-40-25-1 to 25-5, 842-40-30-1, 842-40-30-2 |
| Sublease of suites to physicians | Intermediate lessor | Nothing new for an operating sublease; the head lease stays as it was | Sublease income alongside head-lease cost | 842-10-25-6, 842-20-35-14, 842-30-25-11 |
How does a medical office building ground lease work on the system's books?
In a ground lease, the system keeps title to campus land and lets a developer build on it. In the usual structure, the developer owns the building it puts up. The system is a lessor of land only, so it classifies the ground lease under the lessor criteria.
ASC 842-10-25-2 lists five criteria, and meeting any one makes it a sales-type lease for the lessor:
- (a) the lease transfers ownership of the asset to the lessee;
- (b) the lessee has a purchase option it is reasonably certain to exercise;
- (c) the term is for the major part of the asset's remaining economic life;
- (d) the present value of the payments is at least substantially all of the asset's fair value;
- (e) the asset is so specialized it has no alternative use to the lessor.
If none is met, ASC 842-10-25-3 sends the lessor to direct financing or operating classification.
Some ground leases neither transfer the land nor give the developer a purchase option. For those, work through the present value test in criterion (d). KPMG's Handbook: Leases (Example 4.1.30) works the land element of a 25-year land-and-building lease through that test. It lands on operating classification.
That is one example, not a rule. A long term with high rent can change the answer.
If the ground lease is an operating lease, ASC 842-30-25-11(a) applies. The system recognizes the lease payments as income on a straight-line basis over the lease term. Another systematic and rational basis applies only if it better represents the pattern of benefit.
Under ASC 842-30-35-6, the land itself stays on the balance sheet, measured under other Topics. Where rent escalates, cash and income differ. With rising rent, straight-line income runs ahead of cash at first, so the system carries an accrued rent asset, often called a straight-line rent receivable. A front-loaded schedule gives a deferred rent liability instead.
Each month the system records straight-line rent as lease income. The difference from cash goes to the accrued rent asset or deferred rent liability. The land never leaves the balance sheet.
What changes when the system leases space back in the developer's building?
A system may also sign a lease for floors in the MOB the developer builds on its land. For that lease, the system is an ordinary lessee. ASC 842-20-25-1 has it recognize a right-of-use asset and a lease liability at commencement. The tenant-side mechanics are on the hospital page linked above.
Watch the construction period. When the system controls the building while it is being built, ASC 842-40-55-5 puts the arrangement under ASC 842-40, the sale and leaseback subtopic.
That paragraph lists conditions, any one of which shows control. One is a right to obtain the partly built asset at any point by making a payment. The system can then be the accounting owner of a building it does not hold title to.
Another applies directly to campus ground leases. Under ASC 842-40-55-5(d), the system controls the building during construction if it controls the land and has no land lease in place first that covers the building's life. That means a lease to the developer, signed before construction begins, that with renewals covers substantially all of the building's economic life.
The list is not exhaustive. The Deloitte Roadmap: Leases, section 11.3 discusses it, and the built-to-suit lease page walks through the conditions.
What stops an MOB sale-leaseback from qualifying as a sale?
Systems sometimes sell an MOB they own to a real estate buyer and rent it back. ASC 842-40-25-1 sends the seller to Topic 606 to decide whether the transfer is a sale. Is there a contract? Does the buyer obtain control of the building?
Three MOB-specific facts bear on the answer.
- Repurchase rights. ASC 842-40-25-3 says a seller-lessee option to repurchase precludes sale accounting unless two tests are met. The price must be fair value at exercise, and substantially the same assets must be readily available in the market. KPMG's Handbook: Leases (Question 9.1.30) explains that the FASB views no two real estate assets as substantially the same. So a repurchase option on real estate fails the ASC 842-40-25-3 conditions at any strike price.
- Long leaseback terms. Under ASC 842-40-25-2, a leaseback classified as a finance lease means the buyer has not obtained control. A leaseback for the major part of the building's remaining economic life meets that classification under ASC 842-10-25-2(c).
- Physician tenants already in place. ASC 842-40-55-19 says an existing or intended operating sublease does not, in isolation, prevent the buyer from obtaining control.
When the transfer is a sale, ASC 842-40-25-4 applies. The seller recognizes the sale price and derecognizes the building. It then accounts for the leaseback under ASC 842-20.
ASC 842-40-30-1 and 30-2 then adjust an off-market price. A price below fair value is increased, and the increase is treated as prepaid rent. A price above it is reduced, and the reduction is treated as extra financing from the buyer. Gain mechanics are on the sale-leaseback gain recognition page and what sellers of a sale-leaseback should know.
If it is not a sale, ASC 842-40-25-5 keeps the building on the system's balance sheet. The cash received is recorded as a financial liability. Payments to the buyer then service that liability, and the building keeps depreciating.
On a sale the building comes off, cash comes in, and the leaseback right-of-use asset and liability go on.
What does a hospital record when it subleases space to physicians?
A hospital may lease an MOB floor and sublet suites to independent physician practices. The hospital is then an intermediate lessor. It accounts for the head lease as a lessee and for the sublease as a lessor, as two separate contracts. The sublease strategy guide covers the general mechanics.
ASC 842-10-25-6 requires the sublease to be classified by reference to the underlying asset, the building, not the right-of-use asset. A five-year suite sublease in a building with decades of life left is likely to be an operating lease. The hospital then recognizes straight-line sublease income under ASC 842-30-25-11.
The head lease does not change. Suppose the hospital is not relieved of its primary obligation and the sublease is an operating lease. ASC 842-20-35-14(a) then has it keep accounting for the head lease as it did before. The head-lease right-of-use asset and lease liability stay on the balance sheet, never netted against the sublease.
Income statement presentation is less settled. KPMG's Handbook, Question 8.2.50, notes that Topic 842 has no explicit guidance on it and accepts two views.
One is gross presentation in all cases. The other allows, but does not require, net presentation only when both of these hold:
- subleasing is not a central activity of the entity, and
- the entity subleases to manage occupancy costs and space flexibility.
When is a physician sublease shortfall an impairment indicator?
ASC 842-20-35-14(a) sets the test. If head-lease cost for the sublease term exceeds the sublease income expected for that period, that is an indicator. It signals that the right-of-use asset may not be recoverable. ASC 842-20-35-9 then sends the impairment test itself to Section 360-10-35.
Here is an illustration with every input stated. The hospital leases one MOB floor for 10 years. Rent is paid monthly in advance at $19,400 for years 1 to 5 and $20,600 for years 6 to 10. The discount rate is 5% a year.
At the start of year 6, it subleases the whole floor to a physician group. The sublease runs the remaining 5 years at a flat $18,000 a month.
| Item | Calculation | Amount |
|---|---|---|
| Total head-lease payments | 60 × $19,400 + 60 × $20,600 | $2,400,000 |
| Straight-line head-lease cost per year | $2,400,000 ÷ 10 | $240,000 |
| Accrued rent at end of year 5 | 5 × $240,000 − 60 × $19,400 | $36,000 |
| Remaining head-lease payments | 60 × $20,600 | $1,236,000 |
| Lease liability at sublease start | Present value (PV) of 60 payments of $20,600 in advance at 5% ÷ 12 | $1,096,157 |
| Right-of-use asset carrying amount | $1,096,157 − $36,000 | $1,060,157 |
| Head-lease cost over the sublease term | 5 × $240,000 | $1,200,000 |
| Sublease income over the same term | 60 × $18,000 | $1,080,000 |
| Shortfall | $1,200,000 − $1,080,000 | $120,000 |
The right-of-use asset follows ASC 842-20-35-3(b): the lease liability less accrued lease payments. Straight-line cost has run $36,000 ahead of cash paid. The example assumes no initial direct costs, lease incentives or prior impairment.
Head-lease cost in the test is the straight-line lease cost for the sublease term, $1,200,000. It is not the cash payments of $1,236,000. That cost exceeds sublease income of $1,080,000, so under ASC 842-20-35-14(a) there is an indicator.
The indicator triggers the recoverability test in Section 360-10-35. That test compares the carrying amount of the asset group with its undiscounted cash flows. On these figures alone, treat the subleased floor as its own asset group, with the sublease as its only cash flow. That leaves the head-lease liability and its payments out of the test, which KPMG's Handbook, Question 6.5.10 (Approach A), permits.
Then $1,080,000 of undiscounted income would exceed the $1,060,157 carrying amount. So the indicator would not by itself mean a loss. The asset group and its cash flows decide that, and this page stops there.
The audit file for this should hold the sublease, the head lease and the indicator calculation. The ASC 842 healthcare audit readiness checklist lists what else auditors may request.
Frequently asked questions
Who records the building in a medical office building ground lease?
The developer that builds and owns it, in the usual structure. If the system controls the building during construction, ASC 842-40-55-5 can make the system the accounting owner. If the ground lease is an operating lease, the land stays on the system's balance sheet and the rent is generally recognized as straight-line lease income.
Does a medical office building sale-leaseback qualify as a sale?
Only if the buyer obtains control under Topic 606, as ASC 842-40-25-1 requires. KPMG's Handbook: Leases (Question 9.1.30) explains that the FASB views no two real estate assets as substantially the same. So a repurchase option on real estate fails the ASC 842-40-25-3 conditions at any strike price. A leaseback classified as a finance lease also prevents sale accounting, and a failed sale is recorded as a financing.
How does a hospital account for subleasing office space to physicians?
It keeps the head lease on its books and accounts for the sublease as a lessor. It classifies the sublease by reference to the building, not its right-of-use asset. A short suite sublease in a long-lived building is then likely an operating lease, with straight-line sublease income.
Sources and further reading
- ASC 842-10-25-2 and 842-10-25-3 — how lessees and lessors classify a lease.
- ASC 842-10-25-6 — a sublease is classified by reference to the underlying asset.
- ASC 842-20-25-1 and 842-20-30-1 — what a lessee records at commencement, and how it measures it.
- ASC 842-20-35-3, 842-20-35-9 and 842-20-35-14 — measuring and testing the right-of-use asset, and the intermediate lessor's head lease.
- ASC 842-30-25-11 and 842-30-35-6 — lessor operating leases: straight-line income and the underlying asset.
- ASC 842-40-25-1 to 25-5, 842-40-30-1, 842-40-30-2, 842-40-55-5 and 842-40-55-19 — sale and leaseback transactions, sale-leaseback-sublease transactions and control during construction.
- KPMG Handbook: Leases — chapter 4 (Example 4.1.30), chapter 6 (Question 6.5.10, impairment of right-of-use assets), chapter 8 (subleases, including Question 8.2.50) and chapter 9 (sale-leaseback, including Question 9.1.30).
- Deloitte Roadmap: Leases, section 9.2, Lease Classification (lessor).
- Deloitte Roadmap: Leases, section 10.3, Determining Whether the Transfer of an Asset Is a Sale.
- Deloitte Roadmap: Leases, section 11.3, Lessee's Involvement in Construction Before Lease Commencement.
- Deloitte Roadmap: Leases, section 12.3, Accounting for a Sublease by the Lessee/Intermediate Lessor.
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