What Is a Capital Lease?
In commercial real estate and corporate finance, leases are divided into two main categories: operating leases and capital leases (now formally referred to as "finance leases" under the ASC 842 accounting standard).
An operating lease is a traditional rental agreement where the landlord retains all ownership rights and risks. A capital lease is structured so that the tenant essentially assumes the risks, rewards, and economic benefits of ownership. Even though the landlord legally holds title during the term, the tenant treats the leased asset on their balance sheet as if they bought it with a mortgage.
When Is a Lease Considered a Capital Lease?
The Financial Accounting Standards Board (FASB) provides strict criteria. A commercial lease is classified as a capital/finance lease if it meets any one of the following conditions:
- Ownership Transfer — The lease agreement automatically transfers ownership of the property to the tenant at the end of the term.
- Bargain Purchase Option — The tenant has the option to buy the property at the end of the term for significantly less than its fair market value (e.g., buying a $1 million warehouse for $1).
- Lease Term — The length of the lease covers 75% or more of the asset's estimated useful economic life.
- Present Value — The present value of the tenant's base rent payments equals or exceeds 90% of the property's fair market value.
Tax and Accounting Benefits
Because the tenant is considered the economic owner under a capital lease, they record the property as an asset on their balance sheet and record the rent payments as a liability (debt). Crucially, the tenant is allowed to claim tax deductions for both the interest portion of the payments and the depreciation of the asset, which is a massive financial benefit typically reserved only for landlords.
Related Terms
- Commercial Lease — The overarching contract format
- Base Rent — The payments used to calculate the 90% present value threshold
- Fair Market Value — The baseline used for the bargain purchase option
Barnes Walker Commercial Law
Barnes Walker's attorneys assist businesses in structuring complex commercial real estate leases, ensuring the contract language aligns with the client's financial and tax strategy for capital or operating lease classification. Request a legal inquiry for assistance.
Florida Law Reference
Fla. Stat. Ch. 83, Part II
The Florida Residential Landlord and Tenant Act governs lease agreements, security deposits, maintenance obligations, and the eviction process.
Reviewed by the attorneys at Barnes Walker, Goethe, Shea & Robinson, PLLC