When to Depreciate a Lease

Three factors determine if a lease can be depreciated, as follows:

1.      Lease terms. The lessor owns the property; the lessee uses the property.

2.      The kind of lease. An operating lease provides that the property be returned to the lessor. A capital lease is actually a purchase in which the lease is a means of financing (rather than a bank loan). Therefore, a capital lease has payments that include principal and interest.

3.      Lease conditions. A lease that meets one or more of the following criteria is a capital lease, and the lessee should depreciate the leased asset:

• Ownership is transferred when the lease terminates.

• There is a bargain purchase option (B.P.O.), allowing the asset to be purchased at a price far below its fair market value.
  
• The lease is for 75% or more of the asset's expected life--e.g., if the asset's life is 10 years, the lease term is at least 6 years.

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