Financial lease taxed as ordinary income?

Answer 1

Lease accounting, both for financial and tax purposes, gets rather complex...and frequently treated differently for the 2. Normally addressed from the other side (how to deduct the cost of a lease, and if it should be capitialized), essentially the question is the same: Is it a lease (on the side owning the property, then the income is ordinary income from rental of personal/business property, personal property should be depreciated, if your in the rental business - certain rules may require you to do inventory accounting for that property), or essentially a sales contract with financing (in which case some of the payment is interest received (ordinary income) and some is return of capital....not taxable, but you may have a gain or loss on the sale (which of course is taxed under those rules, including recapture of depreciation of section 1245 - 1250 property at ordinary rates). Some considerations (written from the other point of view, but applicable): You must first determine whether your agreement is a lease and deducted as rent or a conditional sales contract and will be considered as a purchase of the property. If, under the agreement, you acquired or will acquire title to or equity in the property, you should treat the agreement as a conditional sales contract: * A conditional sales contract exists when part of the payments apply to the purchase or entitle the taxpayer a reduced purchase price. * Payments made under a conditional sales contract are not deductible as rent expense. * The costs related to a conditional sales contract must be capitalized and depreciated. Whether the agreement is a conditional sales contract depends on the intent of the parties. Determine intent based on the facts and circumstances that exist when you make the agreement. In general, an agreement may be considered a conditional sales contract rather than a lease if any of the following is true: * The agreement applies part of each payment toward an equity interest that you will receive. * You get title to the property upon the payment of a stated amount required under the contract. * The amount you pay to use the property for a short time is a large part of the amount you would pay to get title to the property. * You pay much more than the current fair rental value for the property. * You have an option to buy the property at a nominal price compared to the value of the property when you may exercise the option. Determine this value when you make the agreement. * You have an option to buy the property at a nominal price compared to the total amount you have to pay under the lease. * The lease designates some part of the payments as interest, or parts of the payments are easy to recognize as interest.