They very well might. IRS & state tax boards are notoriously immune to the concept of ‘fair’. The fact that almost every state doesn’t absolve you of the sale tax burden when you purchase a car just to sell it or the fact that CA only gives you 10 days when it’s near impossible to get it done in that time due to the time their own DMV takes or the fact that even though you don’t owe sales tax on registration or acquisition fee, but if you roll it in you do are all examples where the FTB’s stance is ‘sucks for you, pal’. I’m paraphrasing, not sure that’s the exact verbiage they’d use.
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True, they certainly might. It also likely varies by state, etc. Texas, for example, treats a the starting price of a lease as the basis of a future purchase and sale if the lease includes a clause that allows for a below market price buy out, such as we are talking about here. I haven’t looked through the tax laws of every state to see what they have to say on this specific issue (as I doubt it’s clearly defined). When I have spoken with cpas casually about this topic previously, what I have been told by them is consistent with what I’m suggesting. I’m not a tax professional, so I’m asking pointed questions in line with my understanding. If someone can show definitively what the truth is, I’m all ears.
One should definitely always speak with their own tax professional though, and I think we can all agree that if your positive equity exceeds your lease costs, one definitely owes taxes legally.
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I find it absolutely amazing how complicated tax laws are and will always be, that a simple question cannot be answered with a yes or no.
This Just shows that no matter how simplified they want to make tax laws it will never ever ever ever happen.
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There’s entire industries with vested interest in keeping taxes as complex as possible.
TurboTax (intuit) for one lobbied and got a free filing software option shot down.
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Definition of technocracy. The pentagon will be fully audited before the tax code becomes simplified. IOW, ain’t gonna happen.
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Lots of opinions here but did anyone file a 1099 with the IRS or nah 
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Can you share where in the contract this is described? I don’t think this is correct at all, if it was then all the companies restricting third-party buyouts would have just suspended buyouts and easily made billions on taking the equity this year.
I think what is meant is you can have a lease contract without this clause (true), not that a lease contract with this clause can ignore it (false). It would be breech of contract.
I’m fairly confident that this would be treated like any other embedded call option, which has significant IRS / court precedent. It’s not that ambiguous at all. It doesn’t matter if it’s a widget, futures contract, corporate bond or car as the underlying asset. Also corporations (all large corporations have mandatory IRS audits) lease billions in equipment with buyout options that result in buyout equity, this is well trodden territory not some novel concept (despite it being rare for auto contracts to have equity).
Let me clear the confusion, I did NOT mean one can remove the Option after the contract is executed at will. What I meant is, in a Close-End Lease contract, “The Option” allowing lessee to purchase the vehicle is not an essential part of the contract. Meaning if the the lease contract was offered without this option to begin with, it would not make the Lease Contract invalid.
Exactly, thus your initial comment that the lease payment reflect the “embedded call” option is not valid specially when this clause is not enforceable by the lessor thus they cannot in actuallity put any value to this clause.
Because as we just discussed, having that clause/option, would not have changed the actual lease contract. For example, on this forum, we never discuss how to negotiate a lower RV & one must make sure that the purchase option is properly documented & one make sure that if it is not there, one has to look for a lower payment.
All I am trying to say is that, the Option itself is a non-factor in determining the lease payment & execution of the actual lease contract thus very hard or close to impossible to assign it a value.
In short yes.
Before we get into specifics, we have to agree on certain facts, if we can’t then we will just end up going in circles.
1st - Are we in agreement that in a lease transaction, lessee does not own the asset?
2nd - Are we in agreement that the monthly lease payments are combination of
(a) - Reimbursement of depreciation to lessor, and
(b) - interest expense for lessor extending the credit to you.
3rd - Are we in agreement that none of the lease payments grant the lessee any ownership right to the underlying asset?
4th - Are we in agreement that the “Large Cap cost reduction” is directly related to lowering the depreciation expense for the lessor, thus reduction in the reimbursement to the lessor?
IF we agree on all the facts above,
Then, the transaction of selling of the “vehicle” to the 3rd party is essentially,
- Lessee is selling “The Option” to the 3rd party for a price which is the 3rd party is excersing & the option and taking ownership of the asset.
As the lessee never owns the underlying asset, it can not have any “Equity” in the underlying asset.
As the lessee never owns the asset until the option is excerised.
so if the lessee excerises the option, then the the cost of the asset is the price paid at the time of the option was excerised + (one can argue & IMO it makes sense) the initial cap reduction payment as it can be directly traced to the asset.
Therefore, I agreed with you in regards to the cap cost reduction giving you basis only if the buyout is completed prior to selling the car to the 3rd party.
In a broader sense, if you were to argue to specifically reduced the gain by the upfornt large cap reduction payment I would be more inclined to agree, but I dont think the actual monthly lease payments will give you “basis” in the asset & thus should be included in the calculation when selling either the car or the option for more than the buyout price resulting in a gain.
in the tax world, cash outflow does not automatically mean basis. The classification of the payment determines the basis.
In the tax world, the “structuring” of the transaction has a huge impact on the treatment of the gain/loss from that transaction.
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What’s the cost basis for an auto lease under this treatment?
Why do people want to pay taxes so badly? Do they feel bad for the Government?
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We do, however, often discuss ways that lower the buy out price at any point prior to lease end (see discussions regarding mf mark ups).
It’s incorrect speculation that a lease contract with or without a purchase option would have identical payments. There’s zero proof that’s true,
Also I think you’re confusing “negotiable” vs “non-factor”. If it’s in the contract, it is 100% a factor. It’s like deposition (and acquisition fee) fee is also non negotiable and goes into how they price the lease deal… is it true that IRS capital leases is outside your domain area or do you have some novel guidance there?
I think I included enough pointers for people seriously looking to understand how the IRS would view it (understand you view it differently), folks should discuss with your CPA if you have more questions.
The cost basis of the lease+option+exercise is bundled together, so lease payments + buyout = cost basis for the bundle. The combination of all three components is exchanged for a car. The car inherits that cost basis.
It’s incorrect to think about buyout as cost basis because in a scenario where you put $90k DAS (downpayment + one pay etc) in a 12 year one-pay lease and buyout is a $100 the next day, that $100 is not the cost of the car. Without the lease, they’re not willing to sell you that one day old car for a $100 and you paid more than that to cause the car to be owned by you. (Using extreme example to make this more clear).
Also consumers can’t deduct depreciation on assets, so the fact that an asset depreciated does not impact consumer cost basis. If you’re a business then you can’t double dip and your cost basis is the above less any tax depreciation you already deducted from prior income taxes.
none of this is tax advice and folks should consult their own CPAs.
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Thank you for your assumption but i have been in the industry for more than a decade and there is a clear difference between a Capital Lease transaction (common for expensive business assets) & a Close-End lease (a typical car lease transaction).
From the article above,
" In order to be considered a capital lease, the Financial Accounting Standards Board (FASB) requires that at least one of these conditions must be met:
- Title to the equipment passes automatically to the lessee by the end of the lease term
- The lease contains an option to purchase the equipment at the end of the lease at a bargain price, for substantially less than fair market value; sometimes this is a $1 purchase
- The term of the lease is greater than 75% of the useful life of the equipment.
- The present value of the lease payments is greater than 90% of the fair market value of the equipment."
None if this is true for a typical auto lease. Therefore, i had attached a link to the article below regarding Close End Lease.
“A closed-end lease is a rental agreement that puts no obligation on the lessee to purchase the leased asset at the end of the agreement.
The lease terms in a closed-end lease are more restrictive but the lessee does not assume the depreciation risk of the asset when the lease is over.
Closed-end leases, along with open-end leases, typically apply to leases for vehicles.
Usually, a closed-end lease comes with a fixed rate and a term that may run 12 months to 48 months.”
As you can clearly see the stark difference between the two types of leases & hope you can see how a typical lease transaction is clearly a “Close-End Lease”.
I am not going to assume that “Leases” are out for your domain but it’s sure looks like you’re mixing up your leases & Accounting principles.
Incorrect. As i have pointed out multiple times, lease payments can’t be treated as payment towards purchase of the asset & will not give you cost basis. Lease payments are rent payments, rent payments do not give you basis in the asset you’re renting.
The whole concept of a Close-End Lease is to give “limit” your liability & transfer the risk to the lessor.
The picture is from “actual” lease contract that clearly states you have no ownership right unless you excercise the option. Thus making your lease payments a true rental payment.
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This thread has a lot of fascinating arguments trying to twist a property contract into a financial instrument (which as was discussed the last time it came up, it isn’t - and you’ve shared a lot about treatment of what it actually is), and the possible math of exercising your purchase option at some point in the lease to capture the equity, and what might be taxable.
A better example to consider might be something like
The instances where 2 or less payments were made on a new lease, it’s sold, and depositing the proceeds triggers a Currency Transaction Report with the IRS.
While the IRS can’t be ignored, the states revenue agencies are more concerning, because they can get access to DMV transactions as well as other state data sources that the IRS wouldn’t get.
I ask that question anytime I’m being issued a check over $600 (because the law says a business needs to issue one for any payment to an individual or business over that amount, even if they often don’t), “will you be sending me a 1099?”
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That was not my intention, but as the argument progressed, it was the closest thing i could compare it to.
That wasn’t directed at you. I could have edited what I said better.
Not taken personally & figured i could some explanation to clarify it a bit more.