CLP Lease Law, Tax, and Accounting 2 — Questions and Answers
Question 1: Under the Uniform Commercial Code (UCC) Article 2A, a lease is classified as a 'finance lease' when which condition is met?
- The lessor selects and manufactures the leased goods
- The lessee selects the goods and the lessor acquires them solely to lease to that lessee (Correct answer)
- The lease term exceeds 75% of the asset's economic life
- The lessee has an option to purchase at fair market value
Correct answer: The lessee selects the goods and the lessor acquires them solely to lease to that lessee
Under UCC Article 2A, a finance lease exists when the lessee selects the goods and the lessor acquires them solely to lease to that lessee, with the lessee receiving a copy of the supply contract.
Question 2: Which IRS form is primarily used by lessors to report rental income from personal property leases?
- Form 1099-MISC
- Schedule E (Form 1040) (Correct answer)
- Form 4562
- Schedule C (Form 1040)
Correct answer: Schedule E (Form 1040)
Lessors report rental income from personal property leases on Schedule E (Supplemental Income and Loss) of Form 1040.
Question 3: What does the term 'hell-or-high-water' clause mean in a lease agreement?
- The lessee can terminate the lease under extreme circumstances
- The lessee's payment obligation is unconditional regardless of equipment performance (Correct answer)
- The lessor must repair equipment in all weather conditions
- The lease automatically renews unless formally canceled
Correct answer: The lessee's payment obligation is unconditional regardless of equipment performance
A hell-or-high-water clause makes the lessee's rent payment obligation absolute and unconditional, regardless of any defects, damage, or failure of the leased equipment.
Question 4: Under ASC 842, a lessee must recognize a right-of-use (ROU) asset and lease liability on the balance sheet for which lease type?
- Only finance leases
- Only operating leases with terms exceeding 12 months
- Both finance and operating leases with terms exceeding 12 months (Correct answer)
- Only leases of tangible personal property
Correct answer: Both finance and operating leases with terms exceeding 12 months
ASC 842 requires lessees to recognize ROU assets and lease liabilities on the balance sheet for both finance and operating leases with terms exceeding 12 months.
Question 5: A lessee returns leased equipment in damaged condition beyond normal wear and tear. Which legal doctrine most directly governs the lessee's liability?
- Doctrine of constructive eviction
- Duty to maintain and return in good condition (Correct answer)
- Doctrine of frustration of purpose
- Implied warranty of merchantability
Correct answer: Duty to maintain and return in good condition
Lessees have a duty to maintain leased property and return it in good condition, making them liable for damage beyond ordinary wear and tear.
Question 6: For tax purposes, which factor is NOT part of the IRS's 'true lease' test used to distinguish a lease from a conditional sale?
- The lessor retains a meaningful residual interest in the property
- The lessee has a purchase option at nominal price
- The lessee makes a substantial equity contribution at inception (Correct answer)
- The lessor bears the risk of the asset's decline in value
Correct answer: The lessee makes a substantial equity contribution at inception
A lessee equity contribution is not part of the IRS true lease test; the key factors are the lessor's residual interest, risk retention, and whether the lessee holds a bargain purchase option.
Question 7: Which accounting treatment applies to the initial direct costs incurred by a lessee when entering into an operating lease under ASC 842?
- Expensed immediately as incurred
- Added to the ROU asset and amortized over the lease term (Correct answer)
- Recorded as a separate intangible asset
- Credited against the lease liability
Correct answer: Added to the ROU asset and amortized over the lease term
Under ASC 842, a lessee adds initial direct costs to the measurement of the ROU asset and amortizes them over the lease term.
CLP Lease Law, Tax, and Accounting 2
Under the Uniform Commercial Code (UCC) Article 2A, a lease is classified as a 'finance lease' when which condition is met?