Discussion:How about a backhoe question?
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Discussion Forum Index --> Tax Questions --> How about a backhoe question?
| 11 December 2007 | |
| Client is currently leasing a backhoe. Let's say he began leasing it on October 1 this year. However, he has an option to purchase the backhoe on Dec 15. If he does so, the company will apply all of the lease payments to the purchase price.
What is the date placed in service? 10-1 or 12-15? | |
TheTinCook (talk|edits) said: | 11 December 2007 |
| 10-1. Aren't capital leases considered purchases? Wouldn't make a difference for MQ. | |
Donniecastleman (talk|edits) said: | 11 December 2007 |
| Yep, October 1 on both accounts, either if he continues leasing or buys the "hoe". | |
| 11 December 2007 | |
| Why would you consider it a capital lease? The offer to apply the lease payments is only a carrot to get the company to buy the equipment. This isn't a lease to own deal.
Doesn't that matter? They are merely on a week to week or month to month lease. They have no obligation to keep the equipment. I would assume it's an operating lease, no? | |
TheTinCook (talk|edits) said: | 11 December 2007 |
| I consider it a capital lease because there is an option to buy. I'm relying on FASB Statement #13. | |
| 11 December 2007 | |
| Not enough info given to conclude it would be a capital lease under FASB13. 13 requires lease to be capitalized if any of the following is true: a)Lease transfers ownership at end of term, b) Lease contains a bargain purchase option (e.g., option to buy for $1 at end of term), c)NPV of net minimum lease payments at beginning of term is equal to or greater than 90% of FMV of asset at start of lease or, d)term of lease is equal to or greater than 75% of economic life of asset at start of lease. From 94's second post it appears it is a week to week operating lease that somehow also includes an option to purchase. Nothing indicates the purchase option is anything other than at current FMV. Based on info provided I would say purchase date is 12/15. Additional facts might persuade me otherwise. | |
| 11 December 2007 | |
| Jdugan,
Based on my understanding it is not a capital lease. They could drop it off tomorrow at the dealer's doorstep and not owe another dime. This isn't a long-term lease. | |
TheTinCook (talk|edits) said: | 11 December 2007 |
| The client can apply the lease payments to the purchase price when he exercises his option. Thus it is a bargain purchase option. | |
| 11 December 2007 | |
| FASB 13 paragraph 5d defines a bargain purchase option as: " A provision allowing the lessee, at his option, to purchase the leased property for a price which is sufficiently lower than the expected fair value of the property at the date the option becomes exercisable that exercise of the option appears, at the inception of the lease, to be reasonably assured."
Now, if I go to Rent-a-Dent, rent a $20,000 car for $500/mo on a month-to-month lease with the stipulation that if I decide to buy it I can apply the rents toward the purchase price, there is no inevitability at the start of the lease that I will opt for purchasing the car after two months. | |
| 11 December 2007 | |
| Once again, Jdugan, I agree with you. I just received an email confirming that the lease is month 2 month with no obligation thereafter. It's not a bargain purchase scenario.
It was an agreement from the beginning that if they bought it within 60 days, that the dealer would merely apply the lease payments, made to date, to the purchase price. An extended down payment period. Hmmmmm....are the lease payments added to basis if the asset is purchased and no longer an expense? | |
TheTinCook (talk|edits) said: | 11 December 2007 |
| Hmm, I thought that the presumption is that the lessee will exercise the option. | |
Michaelstar (talk|edits) said: | 11 December 2007 |
| It certainly is not yet a capital lease based on the post. It is an operating lease and the lease payments s/b expensed.
I would say - NO, the two lease payments are not added to the basis of the asset. If the option to purchase is exercised, then at that point a purchase price will be agreed to. If the two lease pmts reduce the total cost, then they would be reclassed as principle payments against the total cost with the balance being booked as the offsetting credit (liability for the o/s loan). | |
| 11 December 2007 | |
| Not really. Sometimes they do. Sometimes the job ends and they don't need it anymore. The problem occurs when the option is exercised in the succeeding tax year. To be consistent I use the same journal entries in each case. DR Equipment Purchase CR Equipment Rental. The rental payment is invariably higher than the lease payment. Placed in service when they commit. Prior to that the rental company depreciates. | |
PHIL MOODY (talk|edits) said: | 12 December 2007 |
| Started to way in, that FASB 13 had no effect on income taxes, and that I would apply the income tax rules, but after reading the post again, I notice the question does not specify tax accounting.
So. I agree with the above that says, there is not enough info. This is all hypothetical of course. See IRS circular 230. | |
| 12 December 2007 | |
| I have erred as to terminology and I didn't realize that yesterday. I shoudl have used the word RENT or RENTAL vs. Lease which implies a contract for a term with options, etc. This is a month-to-month rental agreement, not a lease with additional terms.
Here's the situation. The client installs railroad crossing signal systems (lights, gates, etc.). In the installation process, they require the use of a backhoe. They could hire one out or simply go down to large equipment rental company (who is also a large equipment dealer) and RENT, on a month to month basis, a backhoe to use in their jobs. They choose the latter as they have employees with that expertise. They have come to the conclusion in doing so, that, based on the rental expense of a backhoe, they should simply purchase one. They inquired of the dealer who said "well, if you purchase that one before 12-15, we'll apply the RENTAL payments you have made thusfar to the purchase price." I am sorry for the confusion I have probably caused with regard to this situation. You see, words really do mean things. Do any of you feel that this simplifies or changes anything in this case? | |
| 12 December 2007 | |
| You have to decide whether the rental payments are being refunded and client is then using that refund as sort of a down payment or client is simply getting a discount on the purchase and rental is rental. It all works out the same in the end. You are just talking timing. | |
Death&Taxes (talk|edits) said: | 12 December 2007 |
| This is one time I am glad the original poster did not have all the information. The discussion was very interesting. | |
| 12 December 2007 | |
| Phil Moody, I agree that FASB 13 does not really decide for tax purposes whether a lease should be capitalized or not. (I considered commenting to that effect but remained silent on that point). But, the last time I looked (which was a long time ago, for sure) the FASB rules were a lot more clear than the tax rules as to when the lease s/b capitalized. So I would not have a problem concluding that based on the FASB 13 criteria that the lease s/b capitalized for tax purposes. (CLARIFICATION - I am not saying THIS lease s/b capitalized based on FAS 13, only that if a lease s/b capitalized based on FAS 13 criteria, I would conclude that like treatment was in order for tax purposes. Sorry for the confusion I might have caused.) | |
Michaelstar (talk|edits) said: | 12 December 2007 |
| I would only agree that the lease s/b considered a capital lease once the client elects to purchase the equipment. There is no BPO at the start of the rental period and the option to purchase has yet to be made so it is an operating lease or rental agreement. Rental payments and/or operating lease payments are a current expense.
Once the client "purchases" the equipment and the rental company applies the rental payments to the purchase price, at that point I would reclass those rental payments made as either part of the purchase or against the total liability assuming the asset is financed and not just purchased outright. Until the client signs on the bottom line and assumes the total commitment to purchase the asset with a future stream of payments to pay off a liability it is not a capital lease and should not be treated as such. | |
| 12 December 2007 | |
| From what I am reading it apears that at present it is an operating lease. If the client decides to purchase then it could become a capital lease or it could become a purchase with a loan payable depending on if the client borrows the money on a note or rewrites the lease. I think that I would expense the lease payment then record the purchase at cost of the backhoe minus the lease payments and just go forward. However, reclassifying the lease payments would be ok too. | |
