Basic Leasing Terminology

Leases and rentals are contractual arrangements by which the owner of property (the "lessor") allows another person (the "lessee") to use the property for a stated period of time in exchange for cash payments or other compensation. There is no real legal distinction between a "lease" and a "rental." In practice, however, rentals generally are considered short-term arrangements (a day, a week, a month), while leases are arrangements for longer terms (a year or more).

The two main types of equipment leases you'll encounter are "true" leases and "financial" leases. You also may hear about "sales and leaseback" leases, which in reality are sophisticated financing transactions.

True leases. If the lessee acquires no rights to the property other than its use, then the lease is commonly referred to as a "true" (or "straight") lease. Under a true lease, the lessor is treated as the owner of the leased property for both tax and non-tax purposes, and the lessee's rental payments do not establish any equity in the property. A true lease usually gives the lessee the option to prematurely end the lease, subject to conditions that are spelled out in the agreement.

Financial leases. A lease that is used to effectively finance the purchase of assets is commonly referred to as a "financial" (or "financing" or "finance") lease. The distinguishing characteristics of financial leases are that (1) the duration of the lease generally coincides with the functional or economic life of the property, (2) the lease may not be canceled, and (3) the lessee is responsible for maintaining the property. Frequently, a financial lease will be structured so that the lessee's only practical choice at the end of the lease is to purchase the asset. For example, the parties may agree at the inception of the lease that the lessee will purchase the asset for a specified price (this type of lease is effectively a conditional sales agreement). Or perhaps the lease gives the lessor the right to compel the lessee to purchase the asset or provides the lessee the option to purchase the property for a nominal price.

If the lessor remains responsible for maintaining the property, then a true lease also may be referred to as an "operating" (or "maintenance") lease.

For accounting and tax purposes, financial leases are generally treated as a sale.

Sale and leaseback leases. Under a "sale and leaseback" arrangement, the owner of an asset sells the asset to a third party and then immediately leases it back. The benefit of this transaction is that the owner frees up the cash that was tied up in the asset (through the sale) while still retaining its use (through the leaseback).

To a large extent, your expected need for the leased equipment will determine whether you end up with a true lease or a financial lease. If you expect to need the equipment for most, if not all, of its useful life, then you'll probably end up with a financial lease. In contrast, if you expect that you'll need only the equipment for a specified period and that the equipment will be of use to someone else at the end of that period, you probably can find a lessor who's willing to set you up with a true lease arrangement.

Key lease terms. Here are some of the major terms commonly found in equipment leases of which you should be aware:


Save Money

Although not always explicit in nature, the rental rate for equipment leases frequently has an interest component. Accordingly, when interest rates drop, lease payments may also drop on new equipment leases. Following an interest rate drop, check to see if your lease can be modified. If the lease cannot be modified due to an expensive cancellation provision, investigate buying out the lease with less costly bank financing.