The following Glossary of Equipment Leasing Terms should help all business owners, whether a lessor or lessee, to understand key leasing terms when in the market to acquire equipment. Without some basic knowledge of these terms and qualified legal counsel, it may be substantially more difficult to make an educated decision in any leasing transaction. Please see Part One here.
This refers to the pre-approved amount of funds, i.e., debt that a lessor will extend to a lessee.
Lease purchases are typically considered to be capital leases for accounting purposes because of their bargain purchase option and length of lease term. Lease purchases may include a bargain purchase option for the lessee to purchase the equipment for one dollar at the expiration of the lease. These leases are often referred to as nominal, finance, dollar buyout or buck-out leases and the lease purchase is considered the lease’s full payout, the net lease structured with a term equal to the equipment’s estimated useful life.
This is the monthly or quarterly periodic payment made during the lease term.
This is an addendum or schedule that details particular lease terms of the master lease agreement.
The lease term is the fixed term of the lease represented by the number of months.
Underwriting in the context of leases refers to the process whereby a broker arranges a lease transaction for the benefit of a prospective lessor and lessee. In contrast to “firm commitment” underwriting, it is usually done on a “best-efforts” basis.
A lease is leveraged when part of the acquisition cost of the equipment is financed by a lending institution, and the balance is paid by the lessor. Typically, the debt is non-recourse and the lease payments are sufficient to cover the loan debt service.
This type of lease agreement applies to future equipment not within the contemplation of the parties at the time of the lease’s execution. It allows other equipment to be added to the lease at a later date.
*Modified Accelerated Cost Recovery System (MACRS):
The Tax Reform Act of 1986 established a modified accelerated cost recovery system known as MACRS, a tax depreciation system that allows a business to recover the cost of income-producing equipment over a specific recovery period.
This is a lease that meets the special needs of state and local governments. This type of lease agreement contains a non-appropriation clause which states that the only condition under which the entity may be released from its payment obligation is if the legislative funding authority fails to appropriate funds. A lessee that is a municipality or an organization supporting the government is exempt from the payment of federal income taxes.
This refers to a lease agreement in which the lessee is responsible for paying all costs such as maintenance, taxes, and insurance, related to using the leased equipment. A finance lease is a net lease.
*Off Balance Sheet Financing:
Financing that does not appear on the balance sheets of a lessee as a liability or asset but as an expense because of FASB 13.
A lease which is treated as a true lease, rather than a loan for accounting purposes. Pursuant to FASB 13, an operating lease must meet all of the following requirements: (1) lease term is less than 75% of estimated economic life of the equipment, (2) Present value of lease payments is less than 90% of the equipment’s fair market value, (3) lease cannot contain a bargain purchase option, (4) ownership is retained by the lessor during and after the lease term. The operating lease is not shown as an asset or liability on the balance sheet but as an operating expense.
This refers to the requirement that payment of at least 50% of the invoice cost must be made to a lessor before it provides equipment to a lessee.
*Primary Lease Term:
This is the same as the base lease term.
Payments toward the purchase price that may be required by an equipment manufacturer or builder during the period of construction are referred to as progress payments. These are typically required for costly equipment used during long construction periods. Such payments are designed to alleviate the need on behalf of a manufacturer or builder to expend working capital during these long periods.
This option involves the contract right to buy agreed upon equipment at the times and the amounts specified by the option. It is typically exercisable at the end of the primary lease term but may be exercised during the primary lease term or at the end of any renewal term.
A lessor’s right to sell specified leased equipment to the lessee at the end of the initial lease term for a fixed price.
This is a lessee’s option to renew the term of the lease for a specified rental time and period.
This is represented by the leased equipment’s value at the end of the lease term.
An agreement whereby an equipment buyer buys equipment to lease it back to a seller.
*Skip Payment Lease:
A payment stream whereby a lessee is required to make payments during certain periods of the lease term.
*Step Up/Down Payments:
Such payments change during the lease term, for example, from lower payment amounts at the beginning of the lease term to higher payments later in the lease’s term period.
Also referred to as operating or true leases, this is an arrangement that qualifies for lease treatment for federal income tax purposes.
This term refers to a lease, which qualifies as a true lease, of motor vehicles or trailers that contains a Terminal Rental Adjustment Clause (TRAC) that allows or even requires the rent amount be adjusted based on the sale proceeds of the leased equipment.
With a true lease, the lessee may deduct rental payments and the lessor may claim the tax benefits that normally accrue to the owner of equipment.
This refers to trading in the originally leased equipment for newer, more advanced equipment during the period of the lease term.
The tax charged in lieu of a sales tax for the lease of equipment.
An asset’s useful life consists of its economic usable life.
While a vendor is a seller of property, in the case of leases, it is typically the manufacturer or distributor of equipment.
In this type of program, an equipment lessor provides a lease financing service to an equipment manufacturer’s customers.
A lease backed by a venture capital company for the benefit of start-up businesses.
The attorneys at Glass & Goldberg in California provide high quality, cost-effective legal services, and advice for clients in all aspects of commercial compliance, business litigation, and transactional law. Call us at (818) 888-2220, send an email inquiry to firstname.lastname@example.org or visit us online at glassgoldberg.com to learn more about the firm and to sign up for future newsletters.