How To Know If You Have A True Car Lease

For tax purposes, it’s important to know if the vehicle you think you have purchased is a real purchase. The same applies for leases. In fact, ensuring that vehicle “leases” are true leases and “purchases” are true purchases isn’t just a formality. According to Frank Lyon Co v U.S. 435 U.S.561 (1978), the IRS looks at the actual “objective economic realities of the transaction” to determine whether the transaction is a purchase or a lease. This is important to know because it significantly affects your tax consequences.

How can I know if I’m doing a lease or a purchase?

Here’s how the IRS determines a true car lease.

1. Rent payments build equity.

To be a true lease, no part of the rent can count as equity.

2. You get title AFTER making rent payments.

The IRS says that your lease is a purchase agreement when you get title to the property and when total monthly rent payments equal a stated amount.

3. The lease payments amount is about the same as what you’d pay to buy.

Lease payments are usually lower than a purchase payment. Therefore, if you’re making payments that are similar to a purchase payment, you can’t say it’s a lease.

4. Rent amount is much higher than fair market rent.

Remember that lease payments are usually much lower than purchase payments. For a lease to be a true car lease, the payments must be close to fair market rent for car leasing.

5. Buying for nominal amount at end of lease period.

If your lease agreement states that you only pay $1 for the next 10 years at the end of the lease period, it is not a true car lease. Your payments are, in fact, purchase payments because true car lease agreements have an option to buy the vehicle at fair market value at the end of the lease period. $1 isn’t fair market value for a car!

Run your potential transaction terms by a tax professional. By having a tax and accounting partner for your business, you won’t be sucked into sly business dealings. At Paragon Accounting & Tax, we work side-by-side with entrepreneurs to help them in all their business dealings.