Many times a physician practice will lease a piece of equipment and immediately think it can deduct the lease payments as they are made to the lessor. Many physician practices (and their advisors) forget about knowing when a lease should be treated as a "capital" lease (i.e. the asset leased is capitalized and depreciated and a related note payable is set up payable to the lessor). The following is a excellent summary of the rules by my good friend Bob Cimasi at the Health Capital Group (www. healthcapital.com):
Interpretations of various IRS rulings and accounting standards suggest that a lease transaction should meet the following criteria to qualify as a “true lease”:
(1) At the beginning of the lease term, the leased asset must have a projected fair market value at the expiration of the lease term of an amount greater than or equal to 20% of the value of the leased asset at the inception of the lease, excluding from consideration the effect of inflation and/or deflation and any cost to the lessor for removal. (1)
(2) The leased asset is projected to have the longer of (a) at least 20% of its expected normal useful life (the life projected at the inception of the lease) remaining at the end of the base term; or, (b) a remaining normal useful life of at least one year at the end of the base lease term. (1)
(3) The lessee cannot have a right to purchase or renew the leased asset for a price that is less than its fair market value. (1)
(4) The lessor cannot have a right to force the lessee to purchase the leased asset at a fixed price. (1)
(5) The lessor must have a minimum unconditional equity “at risk” investment equal to at least 20% of the value of the leased asset at all times during the lease term. This can be done in a number of ways: with cash, with other consideration, or by personally assuming the obligation to buy the equipment. (1)
(6) The lessee must not furnish any part of the purchase price of the leased asset, nor have loaned or guaranteed any indebtedness created in connection with the acquisition of the leased asset by the lessor. (1)
(7) The lessor must show the lease transaction was entered into for profit, apart from any tax benefits resulting from the transaction. Total lease payments that the lessee is obligated to pay over the lease term, when added to the equipment’s estimated residual value, has to be greater than the amount of money that the lessor is obligated to pay out for the equipment, such as debt service and equity investment, including any related direct equity financing costs. (1)
(8) The present value of the lease payments cannot exceed 90% of the Fair Market Value (purchase price) of the equipment. (2)
Notes
(1) Source: Revenue Ruling 55-540 and 2001-28
(2) Source: Federal Accounting Standards Board (FASB) Statement 13 - Accounting for Leases
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