Understanding Capital Leases
We previously discussed Fair Market Value leases. Today let’s talk about Capital Leases.
Capital leases also are known as buck-out leases, dollar buyout leases, lease purchases, finance leases, and nominal leases. Unlike Fair Market Value (FMV) leases, purchasing the equipment at the lease’s end is not optional. You do purchase the equipment, and the price you will pay for it is determined at the start of the capital lease. This price can be as low as $1.00, thus the buck-out alternative name.
Is a Capital Lease a Loan or a Lease?
Unlike FMV leases, you own the equipment during the lease, which means you can depreciate it and take advantage of certain tax incentives. According to the Financial Accounting Standards Board, to be considered a capital lease, it must meet a minimum of one of the following:
- The lease transfers ownership of the property to the lessee by the end of the lease term
- The lease contains a bargain purchase option
- The lease term is equivalent to 75 percent or more of the estimated economic life of the leased equipment
- The present value at the beginning of the lease term of the minimum lease payments equals or exceeds 90 percent of the excess of the fair value of the leased equipment
For Which Types of Businesses are Capital Leases Ideal?
Since you own the equipment while you make monthly capital lease payments, the equipment does reflect on your balance sheet. However, it might be an ideal option if you want to reserve your cash. Capital leases might be the ideal choice for equipment that has longevity and little depreciation or chance of obsolescence.