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Before discussing the tax benefits of a lease, you should understand the differences between the two types.


(1) Capital Lease- A lease must pass one of four tests to qualify as a capital lease: the term of the lease must exceed 75 percent of the life of the equipment leased; at the end of the lease, there must be a transfer of ownership to the lessee; over the life of the lease, the payments made must exceed 90 percent of the fair market value of the equipment; or the lessor must include a bargain purchase price as a condition of the lease.


(2) Operating Lease-An operating lease has no transfer of ownership involved, and over the course of the lease, the terms do not meet the qualifications of a capital lease, or the company leasing the property determines up front that it has no intentions of taking advantage of the full contract, in the event the lease does qualify as a capital lease. The determination of a lease type should be disclosed in the company financial statements.


Capital leased equipment is recorded as an asset, subject to depreciation, on the books. Since you are making payments as you would on a loan, you also record an account payable for the term of the full loan. An operating lease is recorded as an operating expense with no related expense. In recap, in a capital lease, the equipment is booked as an asset with a corresponding long-term liability, and in an operating lease, it is recorded as an expense.


The tax benefit of an operating lease over a capital lease depends on the type of asset leased. If the asset is expected to become obsolete before the entire value can be depreciated off the books, then the company may garner a greater tax break from the direct expense of each lease payment. Companies can offset operating expenses dollar for dollar against income earned. The amount of depreciation that can be expensed is controlled by IRS regulations and is based on the IRS's determination of what the normal-use lifespan of the item should be. On the other hand, if the lease is a capital lease, you can expense the interest paid on the lease each year and depreciate the cost of the asset over the life of the asset. Before leasing equipment, consider the long-term benefits each way and whether your estimated life for the use of the equipment correlates to the IRS guidelines. If not, an operating lease may be a better option for you.


Taxing Considerations (Continued)

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