How to Convert an Operating Lease To a Capital Lease

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An operating lease for equipment or property does not count as an asset for a company. The company shows lease payments as an expense, and does not claim ownership of the property that is leased. A capital lease involves partial ownership of the property. In some cases a fully-paid capital lease can transfer all of the property to the company. A capital lease is counted as an asset. The Financial Accounting Standards Board has set criteria for treating an operating lease as a capital lease.

  • Determine if the life of the lease exceeds 75 percent of the life of the asset. If the expected life of the equipment you are leasing is close to the length of the lease (the asset will last less than 25 percent longer than the lease itself), you have a capital lease and not an operating lease. Treat the lease as an asset.

  • Check to see if you will own the asset at the end of the lease. A lease-to-own arrangement is a capital lease. You count this as a capital lease and treat it as an asset. You can depreciate the asset and list it as part of the value of your company.

  • Ask if you have the option to purchase the asset at a discount at the end of the lease. If you do, then treat this as a capital lease. If you want to convert an operating lease to a capital one, ask to have this option added to your terms.

  • Calculate whether the value of the lease payments exceeds 90 percent of the value of the asset. If so, then you can treat this as a capital lease. The value of the asset must be determined by fair market value, so determine what similar assets sell for in the marketplace.

Tips & Warnings

  • Meeting any one of the criteria for a capital lease qualifies it as an asset.
  • Tax benefits are more favorable for operating leases than capital leases.

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