A lessor can claim the tax benefits of a leased asset only if it is a true lease. A true lease is any lease that allows the lessor to claim the tax benefits of ownership of a leased asset arising from the asset’s purchase and lease, while the lessee claims all lease payments as an operating expense. A tax lease allows the lessor to depreciate the leased asset over its economic life and claim any investment tax credits, while the lessee claims lease payments as tax-deductible expense. With a true lease, the lessor has upside residual potential and downside residual risk. As owner of the leased assets, the lessor has the tax benefits of operating leases. Whereas an operating lease is always a true lease, a finance lease may be structured as either a true lease or nontax lease.
True Lease = Lessor Claims Tax Benefits of Asset Ownership
If an asset is expected to become obsolete before it can be fully depreciated, then the lessee may realize a greater tax benefit by using a true lease instead of a nontax lease in order to claim its lease payments as an operating expense deduction each period, rather than record an asset and depreciate it. Moreover, the tax benefits of ownership enjoyed by lessors are generally reflected in lower rental payments on a true lease than on a nontax lease.
| Tax Treatment of True Leases by Lessors and Lessees | ||
|---|---|---|
| Tax Event | Lessor | Lessee |
| Minimum Lease Payments | Taxable as earned | Deducted as accrued |
| Fees Received | Taxable income when collected | N/A |
| Residual Sale/Purchase | Taxable income when collected | Establishes depreciable basis |
| Residual Value Re-Lease | Taxable income as earned | Deducted as accrued |
| Depreciation | Yearly deductions (MACRS) | Not available to lessee |
| Up-Front Fees | Write off straight line over lease term | N/A |
| Fees Paid during Term | Deducted as paid | N/A |
| Interest Expense | Deductible using interest method | N/A |
| Source: ELFA | ||