Leveraged Lease

Leveraged Lease

A leveraged lease is a lease arrangement in which the lessor (the party that owns the asset) finances acquisition of the asset using borrowed funds from a third-party lender. The lessee obtains the right to use the asset for a specified period while the lessor (or its lender) retains title. Leveraged leases are common for high-cost, short- to medium-term assets such as vehicles, construction equipment, and business machinery.

How it works

• The lessor acquires the asset and arranges financing—often combining its own equity with debt provided by a bank or other lender.
• The lessee signs a lease and makes scheduled lease payments to the lessor (or to a trustee/agent), which are used to service the financing.
• Title typically remains with the lessor or the lender during the lease. If the lessee defaults, the secured lender or lessor can repossess the asset.
• Many leveraged leases include a purchase option at the end of the term, though some do not.

Because the lessor finances most of the asset cost with debt, the lessee effectively pays only for the asset’s use (the depreciation and financing cost for the lease term), which can produce lower periodic payments than a full-value purchase loan.

Typical uses and assets

Leveraged leases are often chosen when:
* The lessee does not want to or cannot finance the full purchase price.
* The asset is needed for a limited period (shorter than its useful life).
* Tax, cash-flow, or balance-sheet considerations make leasing attractive.

Common assets: cars, trucks, aircraft, construction and agricultural equipment, and specialized business machinery.

Lease structure and parties

Parties involved:
* Lessor: purchases the asset and leases it to the lessee.
* Lessee: uses the asset and makes lease payments.
* Lender (third party): provides the debt financing to the lessor.

Structures vary: the lessor may supply some equity and borrow the remainder; alternatively, a finance company or bank supplies most of the funding. The exact allocation of title, security interests, and repayment responsibilities depends on negotiated terms.

Leasing vs. financing (purchase loan)

• Leveraged lease: lessee pays for asset use over the lease term; title typically stays with lessor or lender; payments usually cover only a portion of the asset’s value tied to the lease duration.
• Financing (loan to buy): buyer borrows to acquire full title; payments amortize the entire purchase price over the loan term.

Lease payments can be lower because they reflect the asset’s depreciation and use during the lease term rather than full capital recovery.

Accounting considerations

For businesses, lease classification affects accounting treatment. Historically, a lease met the criteria to be treated as a capital (finance) lease if any one of these tests was met:

• Lease term is 75% or more of the asset’s useful life.
• The lease contains a bargain purchase option.
• Ownership transfers to the lessee by the end of the lease.
• Present value of lease payments is 90% or more of the asset’s fair value.

If any criterion applies, the lease is accounted for similarly to an asset purchase (capitalizing the asset and recognizing associated debt). If not, it is generally treated as an operating lease (lease payments recorded as operating expense). Note that accounting standards have evolved (e.g., ASC 842, IFRS 16), so classification and presentation rules differ from earlier guidance; consult current accounting standards or a professional advisor.

Advantages and disadvantages

Advantages:
* Lower periodic outlay compared with financing the full asset value.
* Conserves lessee capital and may improve short-term cash flow.
* Flexibility to return the asset at lease end.

Disadvantages:
* Lessee does not own the asset unless a buyout is exercised.
* Default risk can lead to repossession.
* Accounting and tax treatment can be complex.

Key takeaways

• A leveraged lease uses third‑party debt to finance the lessor’s purchase of an asset that is then leased to a lessee.
• It’s suitable when the lessee wants use of an expensive asset without buying it outright.
• For businesses, lease classification (capital/finance vs. operating) determines the accounting treatment; specific criteria and modern standards should be reviewed with an accountant.