Types of Financing
Types of Lease Programs
There are two types of lease programs available from any finance institution, but because several terms and different “names” are associated with these two programs, it may seem as though leasing is complicated.
Further, the Internal Revenue Service “FASB” tax rules only allow a Lease to be treated one of two ways for tax and accounting purposes.
The first is a type of lease that has a “purchase option” or “ownership option” at the end of the lease term (usually specified to be 10% or 20% of the original purchase price), an option of equipment ownership which will cannot be exercised/decided by the “lessee” or “borrower” until near the end of the lease.
Also commonly termed:
- Operating Lease
- True Lease
- TRAC Lease
- FMV Lease -or- Fair Market Value Lease
In this type of lease, the equipment is typically owned by (and being depreciated by) the funder. The lease payments are for accounting purposes treated as rental payments. This is why the borrower is thereby granted the vastly superior tax write-offs & expense deductions from the IRS for “operating” the equipment- not “owning” the equipment.
At the end of the agreed “rental term” (usually 24-60 months), the “borrower” will decide whether to pay 10% of the original cost of the equipment and assume ownership, or to “abandon” (let the funder have their unit back to sell on the used equipment market) the worn out equipment- and then replace it with a state of the art unit.
The second is a type of lease that has a “residual” payment due at the end of the lease term (usually specified to be $1 or 10% of the original purchase price). This “residual” payment & corresponding ownership at the end of the lease is committed in writing by the “borrower” or “lessee” in the lease documents from the inception of the lease.
Also commonly termed:
- Finance Lease
- Dollar-out Lease
- 10%-out Lease
- Capital Lease
In this type of lease, the lender typically holds a lien against the equipment, but it is owned (and being depreciated by) the borrower.
Unlike a typical equipment loan which is structured with a down payment, of say 10%, this type of lease becomes, in essence, a loan with the “10%” balloon payment payable at the end of the term instead of at the beginning.
The out-of-pocket is usually 1st and last payment.
For tax and accounting purposes, this type of lease is treated just as a loan or a capital acquisition, hence the term “capital lease” and “finance lease”.