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Types of Leases
There is
often confusion over whether the lease is being considered
from an accounting, tax or legal perspective. An accountant,
the IRS, and a tax attorney may use different terms for the
same transaction. To keep terminology clear, it helps to
consider from which perspective the participants are coming.
Below are standard definitions:
Fair Market Value Purchase Option (FMV)
- Delivers the lowest monthly payment of a standard lease with
flexible purchase options at lease end. A Fair Market Value lease is
the preferred option for those concerned about equipment
obsolescence. The
most notable feature of this type of lease is that its structure
does not contemplate a full payout of the cost of the equipment
as is the case in a "Finance" type lease. Two of the common tests
are:
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The term of the lease is generally not greater than
75% of the equipment's anticipated useful life.
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The present value of the lease payments should not
exceed 90% of the fair market value of the equipment using the
lessee's incremental cost of borrowing.
A
significant benefit is that the monthly payments are also less than
on a finance type lease (above) or even a bank loan. Typically the
lessee either returns the equipment at the conclusion of the lease
or may be granted the opportunity to purchase the equipment
from the lessor for "the fair market value." Payments under this
kind of lease structure are treated (by the I.R.S.) as rental
payments and therefore are 100% tax deductible operating
expenses. Also, as rental payments, neither the asset nor its
corresponding liability needs to appear on the company's balance
sheet. The lessor retains the right to depreciate the equipment.
10% Purchase Option
- Also known as a finance lease, this
lease provides ownership at the end of the term at a fixed purchase
price equal to 10% of the original transaction amount. This lease
identifies the eventual purchase price at the start of the lease
transaction. The end-of-lease options include:
With the 10%
predetermined purchase option lease, your payment will be lower than
a One-Dollar Buyout Lease, but may be higher than the Fair Market
Value option.
Capital Lease /One Dollar Purchase Option
- May
also be referred to as ($1) dollar-buyout lease or ($101) one
hundred and one dollar buyout lease. Consider this lease choice if
you intend to own the equipment at the end of the lease, or if the
asset has an expected long life of use. A $1.00 out lease (also
known as a finance lease) provides the benefits of ownership with
the lessee taking depreciation and interest expenses related to the
equipment. At the end of the term, full ownership of the equipment
transfers to the lessee at a cost of $1.00.
With this type of lease there is no uncertainty about the value of
the equipment at the conclusion of the lease as the buyout terms are
generally a part of the initial agreement.
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Finance type lease may not qualify under I.R.S. regulations for
deductibility
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The lessee is considered the owner of the equipment (unlike an
FMV lease) and maintains full control of the residual value
-
The lessee can depreciate the equipment.
-
Lessees records the equipment as an asset and the lease payments
as liabilities on their balance sheet
**Providence Capital
always suggests that you consult you Accountant for the type of
lease best suited for your business.
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