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What Is a Tax-Exempt Lease

Tax-exempt lease or commercial lease: A tax-exempt lease entitles you to a tax-exempt entity (p.B a school), which means that the interest paid is exempt from federal income tax. In a commercial lease, the property is held by a commercial entity and the interest paid is taxed. Commercial leasing can be an inexpensive financial instrument for energy efficiency and renewable energy equipment, subject to significant tax incentives. This is because tax credits can be claimed by the landlord instead of the state or local government (which does not pay taxes). Or maybe you`ve heard of the « first financial cousin » of municipal tenancy, the tax-exempt municipal bond. Both are highly cost-effective methods of financing the purchase of essential-use equipment, vehicles, hardware and software exclusively for state, county and local governments, special districts and authorities. « Municipal leasing » is an umbrella term that applies to all of the above businesses. However, there are some very important differences between leases and bonds, which we will cover below. Both are types of multi-year funding. Both reflect the highly attractive interest rates that characterize their tax-free pricing described above.

But there are SOME VERY IMPORTANT DIFFERENCES for you, the borrower. Leasing contracts have a complex language for defining the financial, tax and legal implications. Some key terms for tax-exempt hire-purchase agreements: Leasing energy-related improvements, especially the use of tax-exempt leases for energy-efficient equipment, is a common and cost-effective way for state and local governments (as well as owners of commercial buildings) to fund upgrades and then use the energy savings to pay for financing costs. Leases often have slightly higher interest rates than bond financing. However, leases are a faster and more flexible tool than many other options, including bond financing, and an important tool for public institutions to finance improvements to their own buildings. The qualification « tax-exempt » or « municipal lease » for this method of financing is associated with the federal exemption from income tax recognized by the lessor on the interest income he receives under the repayment plan. The same tax laws that allow a municipal obligation to be subject to a tax-free rate apply to a municipal lease. Only qualified municipalities or political subdivisions may be eligible for this type of funding agreement. Since the landlord does not pay federal income tax on the interest earned, the tax-exempt lease has a much lower interest rate than other types of leases and installment loans. This significantly reduces the financing costs for the borrower. While very low interest rates on tax-exempt municipal leases are directly compared to bonds, expenses related to issuing municipal leases represent only a small fraction of those involved in documenting and complying with the documentation required for obligations and regulatory compliance (these costs should always be included in your assessment process), which makes bonds a much more expensive option to carry out all but the largest transactions (8+ number / 15-30 years).

Unlike obligations, our municipal leases are subject to the annual allocation of funds in all jurisdictions that require it – meaning that if the funds are not available for a legal reason, the government agency would have the legal prerogative during a fiscal year to terminate the lease after the current budget period without legal penalty and return the equipment/vehicles to us – the owner (not yours). Seller). This is one of the reasons why a municipal lease, unlike an obligation, does not create balance sheet debt in the tenant`s books (municipal unit). Although municipal leases are documented as a lease, they have similar characteristics to a loan. The tenant owns the equipment at the end of the lease and the lease can be repaid in advance. These financing agreements are structured as leasing agreements to take into account the fiscal restrictions on the financing of political subdivisions. In most cases, the obligation ends when the tenant does not provide funds for lease payments for the renewal year. Because of this provision, neither lease nor lease payments (in most states) are considered debts. But first, let`s start with the « tax-exempt » part, as it is sometimes misunderstood.

First, the I.R.S. created tax-exempt municipal leases (and bonds) as a means of providing state, regional, and municipal entities – also known as state and political subdivisions – with access to the lowest financing costs. The I.R.S. This has been achieved by allowing banks and investors to deduct interest income and certain transportation costs from these transactions from their federal income tax, reducing the « business costs » of the funding source and allowing them to lend at much more aggressive interest rates than would otherwise be possible. Hence the « tax-exempt » nomenclature we use to distinguish this unique mode of financing from commercial loans and leases. It is the source of funding that is « exempt » from its federal (and sometimes state and local) taxes. This I.R.S. tax exemption should not be confused with sales (or other) taxes, most, but not all, of which governments are exempt on their typical purchases. Private placement contracts (or leases of individual investors): An investor, e.B. a commercial bank, leasing company or pension fund provides the capital. These leases are attractive for smaller projects, but may also be suitable for larger projects. Interest rates are lower on larger transactions because origination costs are spread over a higher amount financed.

In addition, master leases, which can be private placements or COPs, are similar to a line of credit and may allow tenants to add equipment with a different useful life to existing leases. The main benefit is the reduction of paperwork and approval time. Today, however, framework leases are less used because the lender is unwilling to set prices due to uncertainties in financial markets. A tax-exempt hire-purchase agreement, also known as a municipal lease, assumes that the public sector body will own the assets after the lease term expires. In addition, interest rates are significantly lower than those of a taxable commercial hire-purchase agreement because interest paid for public sector bodies is exempt from federal income tax. Although the financing terms of hire-purchase agreements can extend up to 15 to 20 years, they are generally less than 12 years and are limited by the useful life of the equipment. Purchase of leasing versus actual leasing: In a lease-purchase transaction (also known as leasing or installment leasing), ownership of the equipment is granted to the state or local government when the lease is signed. In a genuine lease transaction, the lessor holds the title until the lease is due.

Note: Rental treatment varies by state. Contact your tax or financial advisor to find out what laws and restrictions apply in your area. Finally, municipal rental prices are set in advance when they are noted and the documents are signed. On the other hand, bond yields vary until the subscriber puts your issue « on the market », where the final interest rates are actually set by other traders and investors. You won`t know the final cost until the number is sold to the public. And you may or may not like the numbers – you may even be back in « first place. » Certificates of Participation (COP): COP are a tool for obtaining financing from several investors. COPs give investors a split stake in one or more underlying leases; Lease payments are passed on to investors based on the portion of ongoing COPs they own, and POPs are ultimately secured by the equipment or assets that secure the underlying lease. Because they are more liquid (i.e., easy to sell to other investors) and spread default risk among a larger number of investors, they typically attract a broader investor base and more competitive terms than private leases. However, there are fixed costs associated with cop issuance, so they can be prohibitive for small projects or one-off projects. The most commonly used lease by state and local governments is a tax-exempt hire purchase agreement, which is an effective alternative to traditional debt financing (bonds, loans, etc.) because it allows a public body to pay for energy upgrades using the money already provided in its annual utility budget.

When properly structured, this type of funding allows public sector organizations to tap into the funds to be saved in future utility bills to pay for new energy appliances and related services today. Leases are contracts that allow a company to maintain (or purchase) the use of equipment or real estate. They are similar to long-term leases, where the tenant uses the equipment for a certain period of time in exchange for regular payments to a third party (landlord). Leases include a call option that can be exercised at the end of the lease term. There are two main methods for obtaining lease financing: Bonds are based on an unconditional pledge of the « full confidence and solvency » of the municipal entity, including a commitment to collect property taxes from each taxpayer in the jurisdiction to the extent necessary to cover the bond debt, if the budgeted funds are insufficient to meet the obligation. For this reason, most obligations require public approval in the form of complicated, time-consuming and expensive electoral referendums. More information on our new special page Municipal Rental:. . .