Capital Lease Reporting

[JohnH]

Client acquires an $85K piece of equipment via a capital lease. Lease payments are $2.5k per month over 48 months, for a total of $120K. Buyout at end of lease period is $1, and lease cannot be prepaid to reduce required payments by any amount. So I ran an amortization schedule and kept adjusting the interest rate until I married up with the monthly payment. (Effective/equivalent rate - 18% FYI. I didn't recommend this lease, folks. The client did this all by himself).

How would you account for the effective interest? Would you deduct the interest according to a normal amortization schedule (heavy on the front side and decreasing as the theoretical loan balance reduces), or would you average the interest deduction at $729 per month for the 48 months?

[Roland Slugg]

This kind of financing, of course, is not a lease but a purchase ... often called a "lease purchase." Account for it for financial statement purposes and for tax purposes as a purchase, using the amortization schedule you backed into. (Using the figures you provided, which I understand may have been rounded for simplicity, the interest rate is 18.07%.)

Since this is really a purchase, the equipment qualifies for the §179 deduction, subject to the usual income and other limits, and any portion of the cost not deducted via §179 can be depreciated under MACRS ... probably using a 7-year life, depending on what it is.

[TAXNJ]

As reply post mentions, if the lease is a capital lease (purchase), the lessee can depreciate the cost of the asset over the life of the asset.

Also, expense the interest paid on the lease each year

[TAXNJ]

Interest rates can be arrived at by using some of the leasing tools available on the internet if need be.

[JON]

Sales Tax

Remember the sales tax, if not exempt, for your purposes it is calculated on the sales price of the leased property. The lessor will charge sales tax on the entire monthly payment, maybe, if you set up the amortization appropriately - it works. Usually leases are a second or worse level of getting financing, but in a few cases, they are trying to get rid of inventory, it can work. The interest charge you mention is below the second level of financing in today's market.

[TAXNJ]

Remember the sales tax, if not exempt, for your purposes it is calculated on the sales price of the leased property. The lessor will charge sales tax on the entire monthly payment, maybe, if you set up the amortization appropriately - it works. Usually leases are a second or worse level of getting financing, but in a few cases, they are trying to get rid of inventory, it can work. The interest charge you mention is below the second level of financing in today's market.

Good point but sales tax on leases varies by state. Suggest ask the Lessor in writing (some states require disclourse) what components make up the price and be done with it.

[JohnH]

Many thanks for all the replies and suggestions.
This discussion has helped me clarify a few fuzzy area as well.