The “end of lease” option determines how the lease terminates, and how the lessee becomes the owner of the leased equipment at the end of the lease. There are essentially 3 common “end of lease” options to choose from:
A dollar buyout option is also known as a capital lease or finance lease. This type of lease is the most similar to bank financing. Basically, the lessee makes payments for the term established on the lease contract at the end of the lease he will have the option to become the owner of the equipment by paying a dollar.
With a dollar buyout or capital lease, the equipment must be shown as an asset and depreciated. Some lessees choose to write the payment off as a rental expense; however, it is not recommended that they do so. The rental payments are usually higher than those of a FMV lease, but the lessee has the advantage of acquiring the leased equipment for a buck at the end.
Since dollar buyout leases are pretty straight forward, many lessees will choose this option. It is important to stress that this type of lease does not take full advantage of the benefits of leasing as outlined on the post Leasing vs Bank Borrowing.
Fair Market Value (FMV)
Fair market value lease or operating lease is an option that may be tax deductible under IRS guidelines where payments are written off as a cost of doing business. In this option, the lessee has the option to purchase the equipment at lease end for its then fair market value, which is estimated at ten percent (10% or greater), or to return the equipment back to the lessor.
10% PUT or Purchase Option
A 10% PUT or Purchase Option, which can actually be 10%, 15%, 20%, or any other percentage determined by the contract, is an “end of lease” option that combines the capital lease and operating lease. The lessee leaves a predetermined percent (usually 10%) of the original equipment cost owing at the end of the lease. The lessee has the option to pay the 10% to take ownership of the equipment or to return it back to the lessor.
This is a common lease option because by leaving a residual at the end of the lease, the lease payments will be lower than if the lease reflected the total equipment cost.
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