The term depreciated lease can be applied to any type of lease agreement signed by a lessee for the use of a lessor's property. Leases are typically tied to the depreciation of the property being leased, so depreciation becomes a major concern in any type of lease agreement reached between two parties. Aside from dictating the terms of the lease, depreciation can also be used by the lessor who earns income from the lease to reduce his annual taxes.
Depreciation and Leases
A lease is a type of financing agreement which allows a lessee the right to use an asset owned by a lessor if the lessee can meet the payment schedule. The asset legally remains the property of the lessor, and in exchange the lessee typically pays more favorable monthly terms than those available through loans. The lease is then calculated as a measure of the asset's depreciation, or loss of value over time, plus interest. Depreciation becomes a much larger consideration for long-term leases, such as auto leases, rather than short-term leases for rental properties.
There are two types of leases used by lessors which create different conditions on the ownership of a leased property: the operating lease and the capital lease. At the end of an operating lease, a lessee promises to return the asset to the lessor, whereas at the end of a capital lease the lessee legally owns the asset. Lessees engaged in capital leases should record depreciation on their asset for taxation purposes. Capital leases either transfer ownership on completion of the lease, contain a bargain purchase option, or BPO, which allows a lessee to purchase the asset below market value, or span at least 75 percent of the asset's expected life.
Depreciating an Asset
The owner of a leased asset which depreciates over time can use the cost of that depreciation to reduce their tax burden every year throughout the expected service life of the asset. An asset can be depreciated on annual tax returns if it is used in business or as an income-producing investment, has a finite service life which can be accurately estimated, and loses value with wear and usage. A portion of the depreciation of a certain asset, such as rental property, can be claimed as a tax deduction or credit on the owner's tax return.
The greater the depreciation gap between an asset's value at the beginning of the lease and its residual value, or expected value at the end of the lease, the larger the lease payments will be. This makes used car leases much cheaper than leases for brand new cars, which lose more value in less time. Favorable depreciated lease terms are best achieved on assets with a residual value of at least 50 percent of the value at leasing.