Finance Lease
In a finance lease, the lessee takes on all the risks and rewards of owning the leased equipment. In other words, the lessee is considered for tax purposes to be the owner of the leased equipment throughout the term of the contract. When the lease terminates, the lessee has an option to buy the equipment at a very low price—usually next to nothing. A finance lease is variously known as a capital lease, a $1 buyout lease, and a full payout lease.
The Financial Accounting Standards Board (FASB) has defined a finance or capital lease as a lease agreement that meets any one of the following criteria:
1. Title to the equipment passes automatically to the lessee by the end of the term.
2. The lease term is equal to 75% or more of the remaining economic life of the asset. “Economic life” means the life of an asset, given normal repairs, upkeep, and maintenance.
3. The present value of the sum of the lease payments equals or exceeds 90% of the fair market value of the asset.
4. The lease contains an option to purchase the asset for a price that is significantly lower than its expected fair market value. A nominal price of $1 is not infrequent.
As “owner” of the asset, the lessee is responsible for the maintenance and repair of the equipment. For this reason, the lease is consid