Commercial Vehicle Leasing: Operating Vs. Capital Lease Options

October 16, 2013

Commercial vehicle leasing is perhaps the best way to equip your business with the cars and/or trucks it needs to operate. There are many benefits to leasing in volume. Aside from the mobility it gives your employees, the small business help is a big asset.

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Types of Leases

There are essentially two types of commercial leases: an operating lease and a capital lease. The differences between the two have important ramifications for your business expenses and tax situation, so it pays to understand them both.

Operating Lease

An operating lease is considered an expense to the lessee - the party doing the leasing. The lessee assumes no ownership stake in the vehicle(s), paying instead for the right to use them. The vehicles are the property of the leasing agent or lessor who in turn accrues the tax benefits involved. This is favorable to the business because the leased vehicles are treated as an operating expense and do not figure on the balance sheet.

Capital Lease

In a capital lease, conversely, the lessee assumes a portion of the ownership of the vehicle(s). Of course, the titles are still held by whoever owns them outright, but because there is joint ownership, the lessee can claim the depreciation of the vehicle(s) and the interest expense from the payments on their annual tax form. With a capital lease, the vehicle(s) are not considered an operating expense and therefore must be placed on the balance sheet as a simultaneous asset and liability-an asset because it is owned; a liability because of the monthly lease payments.

Comparing the Lease Types

There are obvious benefits to using both types of leasing. The lessor, if the arrangement is a operating lease, can claim the vehicle(s) as an asset, and thus accrue the tax benefits arising from the depreciation and the expense of maintaining it. If it is a capital lease, on the other hand, the lessor counts as revenue the future lease payments. Both situations can benefit the lessor, depending on the circumstances.

For the lessee, it is advantageous to be party to an operating lease because then nothing has to appear on their business balance sheet. Since it is not considered an asset, there are no taxes to pay on it. A capital lease, in contrast, must be noted as an asset, but then the lessee is able to write off the depreciation and interest paid.

Businesses tend to want to work with operating leases to keep the vehicles off the books, but in order to do so their lease must not meet any of four conditions. The life of the lease cannot exceed 75% of the asset life, there cannot be a transfer of ownership to the lessee, there cannot be a "bargain price" option at the lease end, and the current lease payments cannot exceed 90% of the fair market value of the vehicle. If the leased vehicles fall into any one of these conditions, the law states it must be considered a capital lease.

For commercial vehicle leasing, businesses and leasing companies alike have different incentives to agree to one of two types of lease: an operating lease or a capital lease. There are benefits to both types-some for the lessor, some for the lessee. As a business owner, check with your accountant to determine which is the best option for your enterprise.

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