Leasing Glossary

Leasing Glossary

Here are brief definitions of the key terms and acronyms used in the leasing industry.

Accelerated Cost Recovery System (ACRS): A method of tax depreciation, or cost recovery, effective for all equipment put into service between December 31, 1980, and January 1, 1987. ACRS replaced the Asset Depreciation Range (ADR) system and, as of 1987, has been replaced by the Modified Accelerated Cost Recovery System (MACRS). Under ACRS, equipment fell into classifications defined as lives of 3, 5, or 10 years. The classification determined the period over which the cost of the asset could be depreciated. An owner of the five-year property could recover 15% of the cost in the first year, 22% in the second, and 21% in each of the next three years.

Advanced Rentals: Any rent payment, which precedes commencement of the base lease term.

Alternative Minimum Tax (AMT): Introduced in 1986, this new form of tax provides a surtax of sorts in which a taxpayer must pay the higher of its regular tax or AMT liability. The AMT makes it more difficult for taxpayers to avoid tax through tax shelters or deferrals.

Asset Depreciation Range (ADR): Method of depreciation used before ACRS. This system established the minimum, midpoint, and maximum number of years over which an asset could be depreciated.

Assignment: A transfer of legal rights. In leasing, a transfer of the lessor’s interest in a lease to another source. Typically, a lessee is prohibited from assigning his interest in a lease without the lessor’s consent, but it is common practice for leasing companies to fund via assignments.

Assumption: A transfer of lease obligations to a third party at the request of the original lessee during the base term of the lease.

Balloon Payment: A final payment that is larger than the periodic rental payments.

Bargain Purchase Option: An option given to the lessee to purchase the equipment for a price well below the reasonable fair market value, thus assuring its sale.

Bargain Renewal Option: An option given to the lessee to extend the lease for an additional term at rental payments well below fair market rental, thus assuring its renewal.

Base Rent: Rental paid during the base term of the lease.

Base Term: The period during which the lessee will have use of the equipment and during which the lessor will receive payments for its use.

Basis Point: One one-hundredth of a percentage point (.01%).

Broker: A company or person who arranges lease transactions between lessors and lessees for a fee.

Buyout: This occurs when the lessee purchases the leased asset from the lessor before the end of the lease term. See Payoff.

Call: The right of a lessee to purchase at a set price. See also Put.

Capitalized Cost: The cost of the equipment plus any applicable initial direct costs. This amount will be shown on the balance sheet and is the amount upon which the tax benefits will be based.

Capital Lease: A lease that meets at least one of the criteria outlined in FASB 13 and must, therefore, be treated like a loan for accounting purposes. The four criteria are:

  1. Title passes automatically by the end of the lease term
  2. The lease contains a bargain purchase option
  3. The lease term is greater than 75% of the estimated economic life of the equipment
  4. The present value of lease payments is greater than 90% of the equipment’s fair market value. A Capital Lease is treated by the lessee as both the borrowing of funds and the acquisition of an asset and corresponding liability (lease payable). Periodic lessee expenses consist of interest on the debt and depreciation of the asset.

Captive Lessor: Captive Lessor: A leasing company that has been set up by a manufacturer or dealer of equipment to finance the sale or lease of its products to end-users or lessees.

Certificate of Delivery and Acceptance: A document that is signed by the lessee to acknowledge that the equipment to be leased has been delivered and is acceptable. Many lease agreements state that the actual lease term commences once this document has been signed.

Chattel Mortgage: A mortgage of personal property such as equipment.

Closed-End Lease: A lease without lease-end options thereby requiring the lessee to return the equipment.

Collateral: Assets used as security to guarantee a debt. In leasing this term is also used to describe the leased equipment.

Commencement Date: The first day of the base lease term.

Commitment Fee: Fee required by the lessor at the time a proposal or commitment is offered to lock the quoted rate.

Commitment Agreement: A document prepared by the lessor that sets forth the terms and conditions of a pending transaction.

Conditional Sales Agreement (CSA): A contract that provides for installment financing of an asset. The lessee is treated as the owner of the equipment for tax purposes but does not become the legal owner until all terms and conditions have been satisfied. Also referred to as a Dollar Buy, Money over Money transaction, or Lease Intended as Security.

Cost of Funds: The cost at which a lessor borrows money to fund transactions.

Deficit Reduction Act: Tax laws introduced in 1984 affect both lessors and lessees, particularly in the area of equipment leased to tax-exempt entities.

Declining Balance Depreciation: A form of accelerated depreciation in which a constant percentage of an asset’s remaining balance is depreciated each year.

Default: Any breach of a designated lease obligation.

Depreciation: An allowance for wear, tear, and obsolescence of equipment; serves as a means to recover the cost of the purchase through periodic deductions to income.

Discount Rate: An interest rate used to bring a series of future cash flows to their present value to state them in today’s dollars.

Economic Life of Leased Property: The estimated period during which the property is expected to be economically usable by one or more users, with nominal repairs and maintenance for the purposes for which it was intended at the inception of the lease.

Economic Recovery Tax Act (ERTA): Tax laws passed in 1981 that introduced ACRS.

End-of-Term Options: Options stated in the lease agreement that gives the lessee flexibility in its treatment of the leased equipment at the end of the lease term. Common end-of-term options include purchasing the equipment, renewing the lease, or returning the equipment to the lessor.

Equipment Schedule: A document incorporated by reference into the lease agreement that describes in detail the equipment being leased. The schedule may state the lease term, commencement date, repayment schedule, and location of the equipment.

Equity Participant: The lessor or one of the groups of lessors in a leveraged lease. Equipment participants hold trust certificates evidencing their interest as owners.

Fair Market Value: The price a willing buyer will pay a willing seller in an arm’s length transaction.

FASB: The rule-making body that establishes accounting guidelines.

Finance Lease: A lease used to finance the acquisition of equipment or as an additional source of working capital. Also, a form of tax-oriented lease that was introduced by TEFRA in 1984, but repealed by the Tax Reform Act of 1986. May be referred to as a Conditional Sale and Dollar Buy.

Financing Statement: A notice of security interest filed under the Uniform Commercial Code.

Fixed Purchase Option: An option given to the lessee to purchase the leased equipment from the lessor on the option date for a guaranteed price. Both the date and the price must be determined at the inception of the lease. A typical fixed purchase option is 10% of the original cost of the equipment.

Floating Rental Rate: Rental, which is subject to upward, or downward adjustments during the lease term, usually proportionate to the prime rate.

Full Payout Lease: A lease in which the lessor recovers from one lessee all costs incurred in the lease plus an acceptable rate of return.

Funding Source: An entity that provides all or part of the funds to pay for leased equipment.

Guaranteed Residual Value: A situation in which the fair market value is guaranteed by the lessee or a third party (e.g. vendor). The guarantor in such a case would make up any deficiency between what was booked and what was realized. A guarantee typically voids the true lease status for a lease transaction.

Guideline Lease: A lease, which meets all the requirements for a leveraged lease as outlined in Revenue Ruling 75-21.

Half-Year Convention: A tax depreciation convention that assumes the lessee put the equipment into use halfway through the year, regardless of when it was put into service.

Hell-or-High-Water Clause: A clause emphasizing the unconditional obligation of the lessee to pay rent for the entire lease term regardless of any event or change in circumstance.

Initial Direct Costs: Those costs incurred by a lessor in negotiating and closing a transaction that has a commission, filing fees, and legal fees.

Interim Rent: Daily rental accruing from funding until a later start date (e.g. lease funds August 28 but is not effective until September 1).

Internal Rate of Return (IRR): The most common method of computing lessor yields that equates to the present value of cash outflows (equipment cost). This yield does not include the value of tax benefits.

Investment Tax Credit (ITC): A credit, which the taxpayer was permitted to take on its Federal tax return as a result of tax ownership of qualified equipment. ITC was repealed by the Tax Reform Act of 1986 for all equipment placed in service after 1985 unless the equipment continues to qualify for ITC because of certain “transitional rules” included in the Act.

Lease: A contract through which an owner of equipment conveys the right to use and possess its equipment to another party in exchange for rental payments.

Lease Intended as Security: A lease in which the lessee is considered the owner for both legal and tax purposes; also known as conditional sale and dollar buy.

Lease Rate Factor: A multiplier that when used against the total cost of equipment will yield the lessee’s payment.

Lease Schedule: A schedule to a “master lease” agreement describing the leased equipment, rentals, and other terms applicable to that equipment.

Lessee: The party to a lease agreement who is obligated to pay the rentals and perform other duties, and is entitled to sue and possess the equipment during the lease term.

Lessor: The party to a lease agreement who has legal or tax title to the equipment, grants the lessee the right to use the equipment for the lease term, and is entitled to the rentals and the residual value of the equipment at the lease end.

Leveraged Lease: A lease transaction whereby the lessor borrows a significant portion of the equipment cost on a nonrecourse basis by assigning the future rent stream to the lender. A leveraged lease is characterized as follows: (1) At least three parties are involved. (2) The financing provided by the lender is substantial to the transaction and without recourse to the lessor. (3) The lessor’s net investment typically declines during the early years and rises during the later years of the base.

Lien: A security interest on the property to evidence a debt.

Limited Use Property: Equipment, which cannot be used after lease expiration in a commercially feasible manner by anyone other than the lessee.

MACRS: Modified Accelerated Cost Recovery System. The specific tax recovery (depreciation) period for a class of assets as defined by MACRS. Asset class lives are used to determine an asset’s recovery period.

Master Lease: A form of lease documentation, which allows a lessee to add equipment to a lease under the same basic terms and conditions without negotiating a new contract.

Minimum Investment: For a lease to be a true lease, the lessor must have a minimum “at risk” investment of at least 20% in a lease when the lease begins, ends, and at all times during the term.

Minimum Taxpayer: A taxpayer whose tax position will require it to pay the new alternative minimum tax, which was introduced by the Tax Reform Act of 1986.

Money Over Money Transaction: A nontax lease. The lease is a conditional sale contract in the guise of a lease.

Multiple Investment Sinking Fund (MISF): Method of income allocation used to report earnings on a leveraged lease, similar to the IRR method, with the exception that it assumes a zero earnings rate during the period of disinvestment.

Municipal Lease: A conditional sales agreement disguised as a lease in which the interest earnings of the lessor are tax-exempt. These leases are available only to municipalities.

Net Lease (“Triple Net” Lease): A lease in which most costs connected with the use of the equipment, including maintenance, insurance, and taxes are paid for separately by the lessee.

Net Present Value: The total value of all future cash inflows and outflows from an investment, when discounted at a specified rate.

Non-Full Pay Out Lease: A lease in which cash flows from the contractual rents are not sufficient to cover the cost of the equipment. The lessor relies on re-sale, renewal, or release of the equipment to recapture its original investment.

Nonrecourse: A type of borrowing in which the borrower is not at risk for the borrowed funds. In a leveraged lease, the lender cannot look to the lessor for repayment of borrowed funds.

Nontax Lease: A type of lease in which the lessee is, or will become, the owner of the equipment and is therefore entitled to all tax benefits associated with the equipment. Also known as CSA, Dollar Buy, and Money Over Money.

Off-Balance Sheet Financing: Any form of financing, such as an operating lease, that for financial reporting purposes is not required to be reported on the firm’s balance sheet.

Open End Lease: A lease in which the lessee has the option to renew or purchase the equipment. Return of the equipment is not mandatory at the lease end.

Operating Lease: A lease that is treated as a true lease (as opposed to a loan) for book accounting purposes. As defined in FAS13 13, an operating lease must have all of the following characteristics:

  1. The lease term is less than 75% of the estimated economic life of the equipment
  2. The present value of the lease payment is less than 90% of the equipment’s fair market value
  3. A lease cannot contain a bargain purchase option (i.e. less than the fair market value)
  4. Ownership is retained by the lessor during and after the lease term
  5. The lessee accounts for an operating lease without showing an asset (for the equipment) or liability (for the lease payment obligations) on his balance sheet. Periodic payments are accounted for by the lessee as operating expenses of the period.

Payments in Advance: A payment stream in which each lease payment is due at the beginning of each period during the lease.

Payments in Arrears: A payment stream in which each lease payment is due at the end of each period of the lease.

Payoff: This occurs when the lessee purchases the leased asset from the lessor before the end of the lease term. See Buyout.

Point: One percent or one percentage point. A point represents 100 basis points.

Present Value: The discounted value of a payment stream to be received in the future, taking into consideration a specific interest or discount rate.

Pricing: Arriving at the rental amount to charge a lessee. A lessor must consider many variables when pricing a transaction including rents, credit risk, term, future interest rates, security deposit, tax benefits, and residual value.

Private Label: An agreement with a third party in which the leasing company funds a transaction while the third party maintains the relationship with the lessee. The lessee does not know about the leasing company’s involvement.

Progress Payments: Progress payments, may be required by the vendor during construction or installation before the closing of the transaction. This money is typically fronted by the lessor and treated by the lessee as a short-term loan.

Purchase Option: An option given to the lessee to purchase the equipment at the lease end. A specific dollar amount typically voids the treatment of the transaction as a true lease.

Put The option in a lease for equipment purchase or renewal that is exercised at the lessor’s, not the lessee’s discretion.

Recourse: A type of borrowing in which the borrower (lessor) is fully at risk to the lender for repayment of the obligation if the user (lessee) does not fulfill its obligations.

Regulation B: The Federal Equal Credit Opportunity Act issued by the Federal Reserve Board requires that, if a business has annual sales of less than $1 million and credit is denied, notification of the reasons for denial be forwarded to the affected business.

Regulation Y: A regulation by the Federal Reserve Board which sets forth business activities in which bank holding companies and their subsidiaries are permitted to engage, including lease activities.

Renewal Option: An option given to the lessee to extend the term of a lease at the expiration of the base term.

Rentals: Payments required under a lease to be made by a lessee to a lessor for the use of equipment.

Residual Sharing: An agreement between the lessor and another party (not the lessee) providing for a division of the residual value between them.

Residual Value: The lessor’s expected fair market value of leased equipment after the lease term.

Return on Assets (ROA): A common measure of profitability based upon net income as a percentage of the amount of assets invested.

Return on Equity (ROE): The yield. The rate earned by the lessor in a lease is measured by the amount and frequency of cash flows permitting recovery of investment.

Safe Harbor Lease: A form of tax-oriented lease introduced in 1981 and, for the most part, repealed by the Deficit Reduction Act of 1984.

Sale-Leaseback: A transaction where one party sells its equipment to another and immediately leases it back.

Section 38 Property: Refers to property in Section 38 of the Internal Revenue Code, and generally defined as tangible personal property used in a trade or business located in the United States.

Sinking Fund: A reserve established for payment of taxes anticipated to become due at a later date (usually applicable only in leveraged leases).

Stipulated Loss Value: The contracted amount which sets the agreed value of the equipment at various times during the term of the lease, and establishes the liability of the lessee to the lessor in the event of depreciation in each year of the equipment’s useful life.

Sublease: A transaction in which leased property is released by the original lessee to a third party while the original lease agreement remains in effect.

Tax Lease: A lease in which the lessor claims tax benefits associated with equipment ownership. Same as a true lease.

Term: The period during which a lease is in effect.

Terminal Rental Adjustment Clause (TRAC): A provision in a motor vehicle lease that permits or requires an adjustment of rentals according to the amount realized by the lessor upon a sale of the leased equipment at lease expiration.

TRAC Lease: A TRAC lease is a true lease of motor vehicles for tax purposes but contains a clause affording the lessee the benefit of knowing its lease-end option up front. The lessor also benefits because the minimum proceeds from the equipment sales, and therefore the yield, are guaranteed.

True Lease: A true lease is a transaction, which qualifies as a lease under the Internal Revenue Code so the lessee can claim rental payments as tax deductions and the lessor can claim tax benefits of ownership such as accelerated depreciation and ITC.

UCC Financing Statement: A document filed with the Secretary of State (and sometimes the country) to provide public notice of a security interest in personal property.

Unguaranteed Residual Value: That portion of residual value for which the lessor is fully “at risk”.

Upgrade: To trade in leased equipment for a newer, more advanced model during the lease term.

Useful Life: The period during which an asset will have economic value and will be usable. The useful life of an asset is sometimes called the economic life of the asset. To qualify as a true lease, the lease term cannot exceed 75% of the expected useful life.

Yield: The interest rate earned by the lessor which is measured by the rate at which the excess cash flows permit recovery of investment.