CLP Lease Law, Tax, and Accounting 3 — Questions and Answers
Question 1: Under the Economic Recovery Tax Act provisions, the Modified Accelerated Cost Recovery System (MACRS) classifies most leased business equipment (5-year property) using which depreciation method?
- Straight-line over 5 years
- 200% declining balance switching to straight-line (Correct answer)
- 150% declining balance over 7 years
- Sum-of-years-digits over 5 years
Correct answer: 200% declining balance switching to straight-line
5-year MACRS property uses the 200% declining balance method switching to straight-line when that method yields a larger deduction.
Question 2: A sale-leaseback transaction where the seller-lessee retains substantially all the risks and rewards of ownership would be accounted for as:
- A true sale and operating lease
- A failed sale and financing arrangement (Correct answer)
- A capital lease with immediate gain recognition
- An operating lease with deferred gain amortization
Correct answer: A failed sale and financing arrangement
When the seller-lessee retains substantially all risks and rewards, the transaction fails sale-leaseback criteria and is accounted for as a financing arrangement rather than a sale.
Question 3: Under the Statute of Frauds, a lease agreement for personal property must typically be in writing if the total lease payments exceed:
- $500
- $1,000
- $5,000 (UCC Article 2A threshold) (Correct answer)
- $10,000
Correct answer: $5,000 (UCC Article 2A threshold)
UCC Article 2A requires a written lease agreement when total lease payments are $1,000 or more; however, many states set the Statute of Frauds threshold at $5,000 for personal property leases.
Question 4: Section 467 of the Internal Revenue Code addresses which specific leasing tax issue?
- Passive activity loss limitations on leased property
- Deferred rent arrangements and prepaid rent accrual mismatches (Correct answer)
- Investment tax credits for qualified leased equipment
- Depreciation recapture upon lease termination
Correct answer: Deferred rent arrangements and prepaid rent accrual mismatches
IRC Section 467 governs leases with deferred or prepaid rent, requiring parties to accrue rent income and deductions based on an accrual method even if payments are uneven.
Question 5: Which of the following is a characteristic of a 'leveraged lease' from the lessor's perspective?
- The lessor provides 100% of the asset cost with no debt financing
- The lessor funds only 20-40% of the asset cost and borrows the rest on a non-recourse basis (Correct answer)
- The lessee assumes all borrowing risk through guaranteed residual payments
- The lease is secured solely by the lessee's corporate guarantee
Correct answer: The lessor funds only 20-40% of the asset cost and borrows the rest on a non-recourse basis
In a leveraged lease, the lessor (equity participant) typically funds 20-40% of the asset cost while non-recourse debt from lenders funds the remainder, magnifying the lessor's tax benefits.
Question 6: In equipment leasing, the 'implicit rate' of a lease is best described as:
- The lessee's incremental borrowing rate at lease commencement
- The rate that causes the present value of lease payments plus residual value to equal the asset's fair value (Correct answer)
- The rate charged by the lessor for late payment penalties
- The weighted average cost of capital of the leasing company
Correct answer: The rate that causes the present value of lease payments plus residual value to equal the asset's fair value
The implicit rate is the rate that discounts the sum of all lease payments plus any unguaranteed residual value to equal the fair value of the underlying asset at lease commencement.
Question 7: A lessee wishes to sublease equipment without the lessor's consent. Under UCC Article 2A, the lessee's right to sublease is:
- Freely permitted unless the lease explicitly prohibits it (Correct answer)
- Automatically prohibited by default
- Permitted only for leases under 12 months
- Allowed but the original lessee is released from all obligations
Correct answer: Freely permitted unless the lease explicitly prohibits it
Under UCC 2A-303, a lessee generally may sublease the goods unless the lease contract explicitly prohibits or restricts such transfer.
CLP Lease Law, Tax, and Accounting 3
Under the Economic Recovery Tax Act provisions, the Modified Accelerated Cost Recovery System (MACRS) classifies most leased business equipment (5-year property) using which depreciation method?