Fair Market Value (FMV)/True Lease/Operating Lease
- 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:
- The term of the lease is generally not greater than 75% of the equipment’s anticipated useful life.
- 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. End of lease features:
- The lessee may have to option to continue renting the equipment.
- The lessee may have the option to “re-lease” the equipment.
$1 Buyout/Capital Lease
- May also be referred to as a nominal or ($1) dollar-buyout lease.
- These leases share the advantage of fixed monthly payments, but with the guaranteed option to purchase the equipment for a nominal price at the conclusion of the lease.
- 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.
- Finance type lease may not qualify under I.R.S. regulations for deductibility.
- 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.
- Lessee records the equipment as an asset and the lease payments as liabilities on their balance sheets.
The “P.U.T.” Option Lease (Purchase Upon Termination)
- This end-of-lease option establishes a mandatory purchase price, usually expressed as a percentage, e.g. “a 10% Put.”
- This is a technique for lowering the lease payments during the lease term without creating an unknown end-of-lease risk for either the Lessor or the lessee.
- Lease payments are fixed.
Equipment Finance Agreement (EFA)
- Equipment Finance Agreements (EFAs) are like $1 Buyout/Capital Leases in that there is intention of ownership at the end of the agreement term.
- The major reason for equipment finance agreements is the avoidance of liability upon the lessor. If you want to lease heavy construction equipment and the use of the equipment causes an untimely death, creative lawyers are going to sue the owner of the equipment. Who is the owner under a lease? The lessor. Who is the user? You. So without a doubt, both the owner and the user will be involved in litigation in that situation. Under an equipment finance agreement, the owner of the equipment is you, the user. So only you, the user, will be involved in litigation and the finance provider will not be, unless there’s some creative lawyering.- Monitor Daily
- Fixed payment until end of term, not subject to varying bank rates.
*Please consult your CPA or tax professional to determine which financing program will be most beneficial to your business