A capital lease is a lease of business equipment which represents ownership and is reflected on the company's balance sheet as an asset. A capital lease, in contrast to an operating lease, is treated as a purchase from the standpoint of the person who is leasing and as a loan from the standpoint of the person who is offering the lease, for accounting purposes.
Capital leases meet the requirements of paragraph 7 of Chapter 13 of the Financial Accounting and Standards Board (FASB). To meet these requirements, a capital lease must meet at least one of these tests:
- Title to the equipment passes automatically to the lessee by the end of the lease term
- The lease contains an option to purchase the equipment at the end of the lease for substantially less than fair market value; sometimes this is a $1 purchase
- The term of the lease is greater than 75% of the useful life of the equipment
- The present value of the lease payments is greater than 90% of the fair market value of the equipment.
Because they are considered assets, capital leases may be eligible for depreciation. Check with your tax adviser before you enter into a capital lease, to be sure it meets the criteria to be depreciable.
