This article was written by Dick Ginnaty, CPA
The words may say “lease” but the detail terms of the financing agreement will determine if the IRS agrees. If they don’t agree than the “lease” will be treated as a purchase (i.e. installment purchase) and the tax attributes (i.e. limits on deductions based on the depreciation rules) of a purchase will prevail.
A “lease” is not a lease if the terms equate to a purchase. IRS says that if the residual payment or buyout at the end of the lease is less than 10% of the “cost” of the property, then it is a purchase agreement, not a lease, regardless of the title on the paper. Such tricks as front loading the “lease” payments so the buyout is low, don’t work.
Factors considered by the court (and IRS) include intent of the parties, whether legal title is transferred, whether “equity” is being created by the size of the payments, which party bears risk of loss or damage to the property, which party pays the property tax, and most importantly the option-to-purchase price in relation to the value of the property (If the option price is substantially less than the fair market value of the property than it will be considered a purchase, not a lease). This last factor, the relation of the option price in relation to the value of the property will be measured at any time during the lease that the option provides for a buyout. In conclusion, the imagination of the leasing agents in structuring the deal and the lure of writing off a 100% cost of a lease should be tempered by the realities of dealing with the IRS.
Good luck and here’s hoping it “all adds up” for you.
(If there is any area in accounting or tax that you think needs to be addressed in this newsletter please e-mail Dick at Ginnatycpa@aol.com and if it is of general interest, he will address it in future articles)