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How the CMS final rule impacts healthcare lease arrangements

Feb 09, 2021

On November 20, 2020, the Centers for Medicare & Medicaid Services (CMS) and the Department of Health and Human Services Office of Inspector General (OIG) issued a final rule, Modernizing and Clarifying the Physician Self-Referral Regulations Final Rule (CMS-1720-F).

The final rule is intended to modernize Stark Law regulations and make it easier for hospitals and physicians to maintain compliance. It also aims to give healthcare providers greater flexibility, reduce regulatory risks and reduce overall costs.

We already broke down the changes related to valuation and compensation, but some of the final rule also pertains to real estate, specifically lease arrangements.

Defining commercial reasonableness

Practitioners know that arrangements must be “commercially reasonable,” but for a long time, they didn’t know the definition of commercial reasonableness. This led to a variety of different interpretations. But no longer. Commercial reasonableness now has a definition. 

The new rule defines commercial reasonableness as an arrangement that “furthers a legitimate business purpose of the parties to the arrangement and is sensible, considering the characteristics of the parties, including their size, type, scope, and specialty. An arrangement may be commercially reasonable even if it does not result in profit for one or more of the parties.”

CMS retained the idea that compensation arrangements subject to Stark Law may be commercially reasonable regardless of whether or not that arrangement generates positive income. The last sentence of the commercial reasonableness definition is key when it comes to lease arrangements. Even if the lease arrangement isn’t profitable, if both entities involved are benefitting in some way (i.e., accomplishing one or more business goals), the arrangement can still be commercially reasonable. As such, whether or not a lease arrangement is commercially reasonable will take several factors from all parties involved into account, including the parties’ size, type, scope and specialty. 

Updating exclusive use requirements

The final rule also changed exclusive use requirements for part-time leases. 

CMS finalized an amendment to the exclusive use requirement in the office space exception that now enables lessees to use office space at the same time as other lessees. With the rise of coworking and shared office spaces, this change modernizes the former Stark Law regulations and provides lessees of medical space with greater flexibility to collaborate and more efficiently use shared office space. 

Correcting errors as part of compliance

A smaller but still impactful change made to the final rule concerns administrative errors, such as typographical or accounting errors and misstated invoices. If an administrative error results in the wrong rent amount being charged, or there are errors in the accounting, you can now go back and correct those errors so long as the lease is ongoing (or it’s within 90 days of the lease’s end date). 

CMS noted that monitoring and resolving errors is key to an effective compliance program. Furthermore, failure to fix these errors can result in noncompliance.

Expanding lease arrangement exceptions

Historically, Stark Law’s office space rental exception has required a lease to be a one-year term or longer, along with other requirements such as the rental rate being set in advance and consistent with fair market value. In 2016, CMS added a timeshare exception, allowing the use of office space, equipment, supplies, services and more by physicians who do not need a traditional office space lease arrangement.

CMS’s final rule has now clarified that lease arrangements not protected under the office space rental exception or the timeshare exception may be protected under the fair market value exception. This means healthcare organizations now have greater flexibility in creating one-off arrangements, such as those shorter than one year, or other unique arrangements like lab draw stations. It also gives them flexibility in leasing non-office space, such as storage space or residential real estate. The example provided by CMS of a protected arrangement described an arrangement in which a teaching hospital provides compensation to a physician to rent his or her home as a residence to house a visiting faculty member.

What do these changes mean for you?

While these revisions are helpful in fixing some ambiguity in the regulations, compliance to the regulations still requires understanding what Fair Market Value is, and that is not always easily assessed.  Fair Market Value requires understanding each financial arrangement and the different considerations needed to assess whether an arrangement can be considered to be within fair market value parameters.  

With the final rule in place and effective since January 19, 2021, ensuring compliance  means having an independent third party perform an assessment of your current lease arrangements to determine whether or not the terms of the lease are  within fair market value parameters. 

Medical lease arrangements can include many different variables (e.g., space, common area expenses, staff, etc.) and can have very different utilization (e.g., time-share, part-time, shared space, etc.). Given this variety, it’s important to engage appraisers who understand the differences in medical lease arrangements and how the final rule impacts these leases. 

And that’s where Wipfli can help. Our valuation specialists perform a valuation to identify whether your lease arrangements meet the fair-market standard and whether they are commercially reasonable given CMS’s new definitions. We can also help structure your lease arrangements to be in compliance with the CMS final rule. Contact us to get started.

Related content:

Valuation and compensation: What the CMS final rule means for hospitals and physicians
Healthcare Perspectives blog
Hospital-physician leasing arrangements: If you’ve seen one, you’ve seen one


Anthony Gullickson
Vice President, Wipfli Corporate Finance
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