4 Types of leases Defined
Capital Lease: A capital lease is a non-cancelable, fully amortized lease, which covers real property but does not cover items such as maintenance services, installation or labor costs.
If there is a purchase option or residual at the end of the lease term, the purchase option cannot exceed 3% of the acquisition cost or it loses its tax-exempt status. A UCC-1 Financing Statement form is filed by the lessor with the State to secure its interest in the asset until the lease-purchase agreement is completely paid.
Installment lease: Under an installment lease the owner usually acts as lessor and investor and holds the lease. Payments commence from the lessee to owner. In an installation lease transaction, title to the asset normally transfers at the first payment. Owner holds a secured interest in the equipment.
Operating lease: This type of lease may have an indefinite term, but is usually for a short duration, such as one year. The rental payment, unlike a capital lease payment, does not act as payment against principal and interest. Since operating leases are not tax-exempt obligations, interest rates quoted are higher to the lessee as the lessor does not realize any tax-exempt benefits. Title to the property remains with the lessor.
Lease agreement with purchase option: During the period of the lease, the lessee makes scheduled rental payments and has the option to:
(i) Purchase the property during the period of the lease;
(ii) Exercise a buy-out and take ownership of the property at the expiration of the lease period or;
(iii) Not renew the lease.
All or a portion of the rental payments are often credited against the purchase price. The purchase price listed at the end of the lease period is also referred to as the residual amount and is negotiated prior to the commencement of the lease.
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