26 Energy Project Financing: Resources and Strategies for Success
agreement. The word “strictly” is appropriate because the Internal Rev-
enue Service will only recognize a true lease if it satisfies the following
criteria:- The lease period must be less than 80% of the equipment’s life.
- The equipment’s estimated residual value must be 20% of its value
at the beginning of the lease. - There is no “bargain purchase option.”
- There is no planned transfer of ownership.
- The equipment must not be custom-made nor useful only in a
particular facility.
Application to the Case Study
It is unlikely that PizzaCo could find a lessor that would be willing
to lease a sophisticated chilled water system and, after five years, move
the system to another facility. Thus, obtaining a true lease would be
unlikely. Nevertheless, Figure 2-11 shows the basic relationship between
the lessor and lessee in a true lease. A third-party leasing company could
also be involved by purchasing the equipment and leasing to PizzaCo.
Such a resource flow diagram is shown for the capital lease.
Table 2-9 shows the economic analysis for a true lease. Notice that
the lessor pays the maintenance and insurance costs, so PizzaCo saves
the full $1 million per year. PizzaCo can deduct the entire lease payment
of $400,000 as a business expense. However, PizzaCo does not obtain
ownership, so it can’t depreciate the asset.Table 2-8. Good Reasons to Lease.
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Financial Reasons- With some leases, the entire lease payment is tax-deductible.
- Some leases allow “off-balance sheet” financing, preserving credit
lines
Risk Sharing- Leasing is good for short-term asset use, and reduces the risk of
getting stuck with obsolete equipment - Leasing offers less risk and responsibility
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