CLFP Tax & Accounting in Leasing 1 — Questions and Answers
Question 1: Under ASC 842, how does a lessee record a finance lease on its balance sheet?
- As a right-of-use (ROU) asset and a corresponding lease liability (Correct answer)
- As an operating expense only with no balance sheet impact
- As equipment owned outright with a corresponding loan payable
- As a contingent liability disclosed in footnotes only
Correct answer: As a right-of-use (ROU) asset and a corresponding lease liability
Under ASC 842, both finance and operating leases create a right-of-use asset and lease liability on the lessee's balance sheet, ending most off-balance-sheet treatment.
Question 2: What is 'bonus depreciation' and how does it benefit equipment lessors and lessees?
- An IRS provision allowing immediate expensing of a large percentage of qualifying equipment cost in the first year, providing significant tax savings (Correct answer)
- A depreciation method that accelerates deductions in final years
- Extra depreciation allowed for environmentally friendly equipment only
- A state-level tax incentive for equipment manufacturers
Correct answer: An IRS provision allowing immediate expensing of a large percentage of qualifying equipment cost in the first year, providing significant tax savings
Bonus depreciation (100% under TCJA through 2022, phasing down after) lets businesses deduct a large percentage of qualified equipment cost immediately, generating powerful first-year tax benefits.
Question 3: What is a 'true lease' for tax purposes and why does it matter?
- A lease where the lessor is treated as the owner for tax purposes and can claim depreciation deductions on the equipment (Correct answer)
- A lease that is exactly 36 months in length
- A lease with no purchase option at the end
- A lease approved by the IRS Revenue Ruling 55-540
Correct answer: A lease where the lessor is treated as the owner for tax purposes and can claim depreciation deductions on the equipment
For IRS purposes, a true lease allows the lessor to claim ownership benefits (depreciation) while the lessee deducts rent payments, which is different from a conditional sale where the lessee owns the asset.
Question 4: What is Section 179 of the IRS tax code in the context of equipment financing?
- A provision allowing businesses to immediately deduct the full cost of qualifying equipment purchases up to an annual dollar limit (Correct answer)
- The code section governing lease accounting under GAAP
- A provision limiting interest deductibility for lessors
- The tax rule for depreciation of real property
Correct answer: A provision allowing businesses to immediately deduct the full cost of qualifying equipment purchases up to an annual dollar limit
Section 179 lets businesses expense qualifying equipment in the year placed in service, up to an annual limit (indexed for inflation), rather than depreciating it over its useful life.
Question 5: What is the MACRS depreciation system and why is it important in equipment leasing?
- Modified Accelerated Cost Recovery System; it is the tax depreciation method required by the IRS for most business equipment, affecting lessor tax benefits (Correct answer)
- A voluntary GAAP accounting standard for lease assets
- A state property tax assessment system for equipment
- A method for calculating residual values
Correct answer: Modified Accelerated Cost Recovery System; it is the tax depreciation method required by the IRS for most business equipment, affecting lessor tax benefits
MACRS assigns equipment to asset classes with specific recovery periods (e.g., 5-year, 7-year) and uses accelerated depreciation methods, maximizing early-year tax deductions for lessors.
Question 6: What is a 'leveraged lease' from a tax and accounting perspective?
- A lease in which the lessor uses debt (typically 60-80% of equipment cost) from a third-party lender to fund the transaction, with the lessor owning the equipment and claiming tax benefits (Correct answer)
- A lease where the lessee borrows to make a down payment
- A lease structured with variable payments tied to market rates
- A government-sponsored lease for infrastructure projects
Correct answer: A lease in which the lessor uses debt (typically 60-80% of equipment cost) from a third-party lender to fund the transaction, with the lessor owning the equipment and claiming tax benefits
In a leveraged lease, the lessor invests only 20-40% equity, borrows the rest on a non-recourse basis, and claims 100% of the tax benefits (depreciation) while the lender has first lien on the equipment and rents.
CLFP Tax & Accounting in Leasing 1
Under ASC 842, how does a lessee record a finance lease on its balance sheet?