This structure offers an end of lease option to purchase the asset at the then current fair market value. That option is one significant factor in whether a lease qualifies as an operating lease according to the IRS. You can generally deduct each monthly payment over the term of the FMV lease. This structure is especially useful in very demanding performance areas where you may want to upgrade equipment before the end of the lease term. At the end of a FMV lease you can:
NOTE: The lender takes a risk in an FMV structure on whether the equipment value at the end of the lease will be equal to the residual value it takes when the lease is entered into. If technology advances make that asset unsellable, it remains the lender’s risk. Typically the lender loses on some of its portfolio residual investments while it gains on others. Managing the assets portfolio value at a future point in time together with the costs incurred in the resale of assets, make the lender’s residual investment decision a dynamic challenge. The FMV structure allows customers to leverage the fact that the leasing companies are much better equipped to remain abreast of used equipment market conditions necessary to effectively liquidate IT assets coming off lease.
There are multiple factors that must be considered in determining whether a lease transaction is a true operating lease, which is a tax deductible expense or a capital lease financing that must be included with the company’s assets. We recommend consulting your tax specialist for more details.
An FPO transfers ownership in the asset automatically to you at the end of the lease term. This structure, as well as any artificially low bargain purchase price that may be offered, is considered a loan (similar to a loan arrangement you would make with a bank). You elect to depreciate the equipment from your taxes over the applicable period, usually 5 years. There is no “trade-in” option at the end of the lease. You own the equipment at the end of the term or for payment of a nominal fee, such as $1.00. This is viewed as pure financing, because you have all the risks of ownership throughout the term of the lease. The IRS recognizes that this structure shifts all the risks of ownership to you, so you are required by the IRS to capitalize the asset.
A capital lease is a financing structure that does not meet the IRS requirements of an operating lease. A capital lease is shown on a balance sheet: if the term of the financing is more than 75% of the asset’s useful life; if the present value of the minimum lease payments over the life of the lease equals or exceeds 90% of the fair value of the asset; or if the asset reverts to your ownership automatically or upon payment of a bargain purchase option (e.g., a $1.00 purchase option) at the end of the term.
A deferral structure provides customers extended non-standard payment terms. A deferral feature may be included with a lease transaction, such that the lease payment may not start for 90 days; or it may call for extended payment terms in a sales transaction, e.g., 50% in 180 days or 50% in 365 days. In a deferred sale the title transfers to the customer and depreciation and accounting treatment start immediately. As a result deferrals are often used at the end of a year to deploy equipment in time to receive favorable tax treatment, or for typical customers to deploy assets before their capital budgets have been approved.