Many businesses choose to lease their equipment. The following four criteria can determine if it is a capital lease:
- Ownership: The ownership of the asset is shifted from the lessor to the lessee by the end of the lease period; or
- Bargain purchase option: The lessee can buy the asset from the lessor at the end of the lease term for a below-market price; or
- Lease term: The period of the lease encompasses at least 75% of the useful life of the asset (and the lease is noncancellable during that time); or
- Present value: The present value of the minimum lease payments required under the lease is at least 90% of the fair value of the asset at the inception of the lease.
If a lease agreement contains any one of the preceding four criteria, the lessee will record it as a capital lease. The lessee capitalizes the asset and would then have depreciation expense as well as other possible deductions, including a 179 deduction and applicable interest deduction. If the lease is truly an operating lease, the only expense would be the monthly lease payment.
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