A fixed-purchase option (FPO) is the lessee’s contractual right to buy the asset at the end of the original lease term for a fixed percentage of its original cost. The lessee’s option to buy the leased asset at the end of the lease term for its fair value determined at lease expiration by an appraiser or other expert in the asset is a fair-value purchase option (FVPO).
If the lease contains a FVPO, it is a true lease and the lessor claims the tax benefits of ownership of the leased asset. To preserve the tax characteristics of a true lease, the lessee cannot purchase the asset at a price less than its estimated fair market value.
| Fair-Value Leases at Termination | |
|---|---|
| Possible Course of Action | Price |
| Extend the Lease | FMV |
| Purchase the Asset | FMV |
| Walk Away | – |
A lease with a 10% purchase option is an operating lease in which the lessee has the right to buy the leased asset at the end of the lease term for 10% of the original purchase price. This lowers monthly payments by deferring 10% of the asset’s price to the end of the lease term, it keeps the asset off the lessee’s books and also gives the lessee the option to return the asset if it is not interested in ultimately owning the asset.
The opposite of a 10% purchase option is a 10% PUT option, which requires the lessee to purchase the equipment for 10% of its original purchase price and makes it an obligation of the lessee rather than an option. It lowers the payments over a traditional $1 buyout lease while guaranteeing the lessor the full residual value.
| Common Forms of Lease Purchase Options | ||||
|---|---|---|---|---|
| 10% Purchase Option | 10% PUT* Option | Fair-Value Purchase Option | $1 Purchase Option | |
| Monthly Payments | > FVPO | Depends† | Lowest | Highest |
| Purchase Option | 10% of Cost | 10% of Cost | Fair Value | $1 |
| End-of-Lease Price | Set at Inception | Set at Inception | Set at Purchase | Set at Inception |
| Ownership Decision | At Lease Term | At Lease Term | At Lease Term | At Inception |
| Lessee Right/Obligation | Right to Buy, Upgrade or Return | Right to Buy | Right to Buy, Renew, Upgrade or Return | Right to Buy, Upgrade or Return |
| Lease Type | Finance Lease | Finance Lease | Operating Lease‡ | Finance Lease |
| Lessee Tax Benefits | Depreciation + Interest Expense | Depreciation + Interest Expense | Interest Expense | Depreciation + Interest Expense |
| * Purchase Upon Termination † Could result in the lowest if the 10% PUT is a higher value than the expected FMV ‡ Because its exercise is less than certain at lease inception. | ||||