To determine whether the payments you make for a piece of equipment, such as a forklift or truck, are deductible lease payments or if you should depreciate the cost of the equipment, you must first establish whether the agreement is a lease or a conditional sales contract. This determination is based on the intent of the parties as evidenced by their agreement and the facts and circumstances at the time the agreement was entered into.
Lease vs. Conditional Sales Contract:
- Lease: If the agreement is a lease, you may deduct the payments as rent under section 162(a)(3) of the Internal Revenue Code, which allows for the deduction of ordinary and necessary expenses paid or incurred during the taxable year in carrying on a trade or business, including rentals or other payments required to be made as a condition to the continued use or possession of property.
- Conditional Sales Contract: If the agreement is a conditional sales contract, you are considered the outright purchaser of the equipment. In this case, you may generally recover the cost of the property used in a trade or business through depreciation deductions under section 167(a) of the Code, which provides for a reasonable allowance as a depreciation deduction for the exhaustion, wear and tear, or obsolescence of property used in a trade or business.
Factors Indicating a Conditional Sales Contract:
- The agreement designates part of each payment towards an equity interest that you'll receive in the property.
- You get title to the property upon the payment of a stated amount of "rental" payments required under the agreement.
- The amount you must pay to use the property for a short time is an inordinately 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.
- The agreement designates some part of the payments as interest, or parts of the payments are easy to recognize as interest.
Depreciation of Equipment:
- If the agreement is determined to be a conditional sales contract, you will depreciate the cost of the equipment. Tangible personal property, such as machinery and equipment, qualifies for depreciation under section 167 of the Code.
- You may also elect to recover all or part of the cost of certain qualifying property, up to a limit, by deducting it in the year you place the property in service under section 179. This is known as the section 179 deduction.
Special Rules for Property Subject to Lease:
- If any property is acquired subject to a lease, no portion of the adjusted basis shall be allocated to the leasehold interest, and the entire adjusted basis shall be taken into account in determining the depreciation deduction with respect to the property subject to the lease (section 167(c)(2)).
In summary, whether the payments you make for a piece of equipment are deductible lease payments or if you should depreciate the cost of the equipment depends on whether the agreement is classified as a lease or a conditional sales contract. If it is a lease, the payments are deductible as rent. If it is a conditional sales contract, you will depreciate the cost of the equipment.
Sources:
CCA 200242006
§ 167. Depreciation
§ 179. Election to expense certain depreciable business assets
Publication 946 (2023)
PLR 9246012
PLR 9303016
