ASC 842

What does "ASC 842" mean in real estate?

ASC 842 is the U.S. GAAP lease accounting standard issued by the Financial Accounting Standards Board (FASB). In real estate, ASC 842 requires most leases—especially longer-term leases for office space, retail stores, and other property—to be recognized on the lessee’s balance sheet. That change increased transparency by making lease obligations visible to investors, lenders, and other stakeholders.

Quick definition

Under ASC 842, lessees must record a Right-of-Use (ROU) Asset and a Lease Liability for most leases with a term greater than 12 months. The ROU asset represents the lessee’s right to use the leased property; the lease liability is the present value of future lease payments.

Key concepts

• Right-of-Use (ROU) Asset: An asset recorded on the balance sheet representing the right to use leased real estate over the lease term. The ROU asset is amortized over time.
• Lease Liability: The present value of future lease payments, discounted using the lessee’s incremental borrowing rate or the lease’s implicit rate.
• Lease Classification: Leases are classified as either operating leases or finance leases. Classification affects the pattern of expense recognition on the income statement.
• Lease Term: Includes the non-cancelable period plus any renewal or termination options that are reasonably certain to be exercised.
• Embedded Leases: Contracts that include both lease and service components must be evaluated and, where appropriate, separated for proper accounting (embedded lease).

How ASC 842 works in practice (real estate examples)

Example 1 — Office space lease

A company signs a 5-year lease for office space with monthly rent of $10,000. Under ASC 842 the company:

• Calculates the present value of the lease payments using an appropriate discount rate.
• Records a ROU asset and a lease liability for that present value on the balance sheet.
• Recognizes interest expense on the lease liability and amortization of the ROU asset over the lease term; cash payments reduce the lease liability.

Example 2 — Retail lease with tenant improvement allowance

A retailer leases a storefront for 10 years and receives a $200,000 tenant improvement allowance from the landlord. Under ASC 842:

• The allowance is treated as a lease incentive that reduces the initial measurement of the ROU asset.
• Lease payments and incentives are included in the determination of the lease liability and ROU asset.
• The retailer amortizes the ROU asset over the lease term, reflecting both the rent and the incentive in the accounting.

Example 3 — Sale-leaseback transaction

When a company sells a building and leases it back, ASC 842 requires evaluation to determine whether the transfer qualifies as a sale. If it qualifies, the seller-lessee recognizes any gain or loss on the sale and records a ROU asset and lease liability for the leaseback. If it doesn’t qualify, the transaction is accounted for as a financing arrangement. See also sale-leaseback.

Business and real estate impacts

• Greater transparency: Investors and lenders can see lease-related obligations that were previously off-balance-sheet.
• Higher reported liabilities: Many companies reported significant increases in total liabilities when ASC 842 was adopted.
• More complex accounting: Organizations must track lease terms, renewal options, embedded leases, and incentives—often requiring updated systems and controls.
• Lease negotiations: Tenants and landlords may change structuring and negotiation strategies to manage balance-sheet and income-statement impacts.

When ASC 842 applies

ASC 842 applies to most leases of real estate and other property where the term is longer than 12 months. Short-term leases (12 months or less) can be accounted for off-balance-sheet if the lessee elects the short-term lease practical expedient. Leases with both lease and non-lease components must be allocated between those components unless the lessee elects the practical expedient to account for them together.

Practical considerations for real estate professionals

• Advise clients about accounting impacts when negotiating lease length, renewal options, termination clauses, rent holidays, or tenant improvements.
• Coordinate with clients’ accounting teams to ensure lease data (payment schedules, options, incentives) is captured accurately for measurement.
• Be aware that reported financial ratios (debt-to-equity, leverage metrics) may change when leases are capitalized under ASC 842.

Bottom line

ASC 842 fundamentally changed lease accounting for real estate by bringing most leases onto the balance sheet through a ROU asset and lease liability. The standard increases transparency and comparability but adds complexity to lease accounting and negotiation. For landlords, tenants, and advisors, understanding ASC 842 is essential to assessing financial impacts, structuring deals, and maintaining compliance.