Suresh Makam – 914-899-7912
Citi Bankers Leasing

– Lessor purchases the equipment with equity or proceeds of recourse loan
– Lessor’s return depends upon Lessee’s credit and equipment value
– Lessor is 100% at risk
• There are no non-recourse loan amounts

3

– Revenue Procedure 75-21
– Revenue Procedure 75-28
– Revenue Procedure 76-30
– Revenue Procedure 79-48

In Revenue Procedure 2001-28 , the IRS stated that:
• To qualify for an advance ruling regarding the tax
• status of a leveraged lease, a lease contract must
• adhere to the following guidelines: a. Minimum unconditional “At Risk” investment i.
Minimum Investment must remain equal to at least 20% of the cost of the property at all times throughout the entire lease term.
ii.
Equipment must have a remaining useful life beyond the lease term of the longer of one year or 20% of the originally estimated useful life.

IRS Guidelines: Rev Proc 2001-28 (cont’d) b. Purchases and sale rights i.
No bargain purchase options allowed (established by case law) ii. No Put option to Lessee c. No investment by lessee i.
No part of the cost of the property may be furnished by Lessee ii. Lessee may pay for certain improvements or additions

IRS Guidelines: Rev Proc 2001-28 (cont’d) d. No lessee loans or guarantees e. Profit requirement (complex IRS formula) f. Positive cash flow (complex IRS formula) g. No Limited Use property

IRS Guidelines: Rev Proc 2001-28
(cont’d)
– Rev Proc 2001-28 is best understood as a “bright line” test, but case law has been more flexible
– Neither the IRS nor the tax courts have worked out a fully comprehensive articulation of the differences between a true lease and a non-true lease
– Guidelines are safe harbor and are technically applicable only to leveraged leases

• Examine all facts and circumstances to determine if
• lessor has upside residual potential and downside
• residual risk. Downside risk is weighed heavier
• than upside potential.
• Three questions:
1.
Is there a bargain purchase option?
2.
Is the Lessee economically compelled to purchase the equipment at the end of the lease term or at the fixed purchase option if any (“EBO”)?
9

3. Is it commercially feasible that someone other than
Lessee will use the property after the lease expires?
– Limited use property
– Useful life
– Residual value
10

Examples of True Lease Structures
– Purchase option fixed at reasonable estimate of FMV
– Early termination at option of Lessee who guarantees sales price on sales to third party, by way of a cancellation payment
– Non-bargain purchase option (“EBO”) during the base term; provided that if purchase option is not exercised the term is extended with a Fair Market Value (FMV) option at the end of renewal term (first amendment)
– 3rd party residual guarantee (not a put)
– TRAC leases See IRC Sec. 7701(h)
11

Examples of True Lease Structures (contd)
– Leveraged Lease
• Lessor purchases the equipment with equity and proceeds of non-recourse loans.
– Cross Border Lease
• Lessor leases property to be used outside the
Lessor’s country of domicile.
– Double Dip Lease
• A cross border lease in which both lessor and lessee are entitled to tax benefits in their respective countries of domicile as tax owners.

Examples of Non-True Lease Structures
– Bargain Purchase option (including $1 out)
– Synthetic leases: Product term for a lease that takes advantage of inconsistencies in tax and accounting rules for the benefit of the lessee. Lease is structured as a conditional sale (or financing) for tax purposes, and an operating lease for lessee accounting purposes. Lessee has purchase option (upside) and guarantees a portion of residual value (the riskiest portion so that Lessee has predominant downside risk). Thus, the lessee takes the tax benefits of ownership, but gets off balance sheet accounting
– Loans and conditional sales agreements
13

100%
Fair Market Value Curve
(FMV)
Stipulated Loss Value (SLV)
Early Buyout
Option (EBO)
FMV
Residual
Year
1 2 3 4 5 6 7 8 9 10

A. A true lease is accounted for as a lease for income tax purposes:
LESSOR
Rent Taxable income as earned (advance rents – when collected; arrears rents – accrue into proper period)
Taxable income when collected Fees Received
Residual:
Sale/Purchase Taxable income when collected
Re-lease Taxable income as earned
Depreciation
Fees paid
Up front:
Yearly deductions (MACRS)
Write off straight line over lease term
Over life Deducted as paid
Interest Expense Deductible using interest method
LESSEE
Deducted as accrued
N/A
Establishes depreciable basis
Deducted as accrued
Not available to lessee
N/A
N/A
N/A

B.
A non-true lease or a synthetic lease is accounted for income tax purposes as an installment sale (i.e., a loan or financing):
LESSOR
Rent
Depreciation
Allocated between interest income and return of principal
Not available to lessor, since it is not the owner for tax purposes
Interest Expense Deductible using the interest method
LESSEE
Allocated between interest expense and payment of principal
Yearly deductions (MACRS)

•
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– Type of equipment (Aircraft, Vessel, Manuf
Equip)
– Use of the equipment by lessee (US, Foreign
)
– Location of the equipment (US, Foreign)
– Lessee’s status (US or non-US entity)
– Lessee’s status (US tax payer or Not)
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Tax Depreciation
Depreciation Methodology
1.
Modified Accelerated Cost Recovery System (“MACRS”) applies to all property placed in service after December 31, 1986.
2 .
Under MACRS, there are six classes for personal property; depreciable lives are based on asset class lives:
3-Year Class
• Includes property with an asset class life of 4 years or less
• Examples include special tools and over-the-road tractor units. Specifically excluded are automobiles and light trucks.
5-Year Class
• Includes property with an asset class life of more than 4 years and less than 10 years
• Examples include computers, data handling equipment (typewriters, calculators, copiers, etc.), heavy general purpose trucks, trailers, general construction equipment. Specific property added to 5-year class includes automobiles, light trucks, qualified technological equipment (“QTE”), computer-based telephone central office switching equipment, research and experimentation property.
7-Year Class
• Includes property with an asset class life of at least 10 years and less than 16 years
• Examples include office furniture, fixtures, and equipment and commercial aircraft. Specific property added to 7-year class includes single-purpose agricultural structures, and property with no ADR midpoint that is not classified elsewhere

Depreciation Methodology (cont.)
10-Year Class
• Includes property with an asset class life of at least 16 years and less than 20 years
• Examples include barges, coal gasification equipment, and petroleum refining equipment.
15-Year Class
• Includes property with an asset class life of at least 20 years and less than 25 years
• Examples include industrial steam and electric generation and/or distribution systems, cement manufacturing equipment, water transportation property, railroad wharves and docks. Specific property added to 15-year class includes municipal wastewater treatment plants, and telephone distribution plant and comparable equipment used for the two-way exchange of voice and data communications.
20-Year Class
• Includes property with an asset class life greater than or equal to 25 years
• Examples include farm buildings, railroad structures, telephone distribution plants.
3.
The cost of property in the 3-, 5-, 7-, and 10-year classes is recovered using the 200% declining-balance method over three, five, seven, and ten years, respectively, and the half-year convention, with a switch to the straight-line method in order to maximize the deduction. The cost of 15- and 20-year property is recovered using the 150% declining-balance method over
15 and 20 years, respectively, and the half-year convention, with a switch to the straight-line method in order to maximize the deduction.

• Alternative Depreciation System (ADS)
– Property used predominantly outside the US, or
– Lessee is a tax-exempt entity (includes foreign entities)
• Depreciation under ADS is determined by using
– Straight line method
– Applicable convention
– Recovery period equal to class life, but not less than
125% of the lease term in certain cases
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• If more than 40% of all personal property placed in service during the year is placed in service in the last 3 months of the taxable year, all personal property placed in service during the year is subject to a mid-quarter convention .
– Property placed in service and disposed of within the same tax year is excluded in determining the 40% aggregate basis
– Test applies on a consolidated basis but with respect to partnerships it generally applies at the partnership level

• If the taxpayer triggers the mid-quarter convention, the half-year convention no longer applies. The first year depreciation amount for all personal property placed in service that year will be recalculated according to the quarter it was placed in service .
– 1 st Qtr: 10.5 months
– 2 nd Qtr: 7.5 months
– 3 rd Qtr: 4.5 months
– 4 th Qtr: 1.5 months

• The Gulf Opportunity Zone Act Of 2005 for small business sector in Louisiana, Mississippi, And
Alabama. Provisions of the GO-Zones Law will:
– Double small business expensing from $100,000 to
$200,000 dollars for investments in new equipment;
– Provide a 50-percent bonus depreciation for businesses that invest in new equipment and new structures.

• The Energy Policy Act of 2005 (“the Energy Act”)
– Congress again chose to encourage renewable energy development in the United States through an array of tax incentives rather than direct grants or subsidies.
• The Section 45 credit is available for facilities that generate electricity from wind, closed-loop biomass, geothermal deposits, landfill gas and trash combustion.
– The Energy Act extends the Section 45 production tax credit for additional two years,
– Allowing qualified facilities placed in service through
December 31, 2008.

• The Energy Act adds the following investment tax credits to code Section 46:
– 30% credit for solar energy property
– 20% credit for integrated gasification combined cycle projects,
– 15% credit for other advanced coal-based technologies,
– 20% credit for certified gasification projects,
– 30% credit for qualified fuel cell power plants, and
– 10% credit for qualified stationery micro turbine power plants.

•
•
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Rental Income - Section 467
• Rental income should be approximately level over the term of the lease.
• Some forms of “uneven rent” are acceptable
– Rents that vary:
• Due to third party costs
• With an index
• With asset use
• Vary by a small amount
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Rental Income - Section 467
(con’t)
– Property taxes
– Utility costs
– Insurance costs
– Maintenance costs
29

Rental Income - Section 467
(con’t)
– Consumers Price Index
– Producers Price Index
– Regional Price Index
– Commodity Index (fuel or food prices)
– Financial Index
30

Rental Income - Section 467
(con’t)
– Variation with output of a leased equipment
– Mileage on a vehicle
– With sales (retail store)
– Variation with profitability (retail store)
31

Rental Income - Section 467
(con’t)
• Rents that vary by a small amount
• The “90-110 Test”
– 10% variation is allowed
– Determine the average annual rental rate
– Lowest annual rental must be at or above 90% of the Average
– Highest annual rental must be at or below 110% of the average rent
– Real Estate allows 15% variation (“85-115 Test”)
32

Rental Income - Section 467
(con’t)
– IRS may determine that the agreement is a
“ Disqualified Agreement ”
– If a “Disqualified Agreement,” The IRS may recalculate the rental income pattern
(“ Levelize ”)
– If the agreement is a Disqualified Agreement, the entire agreement will be levelized.
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Example of SITL - Assumptions
Asset:
Asset Cost:
Lease type:
Term:
Delivery Date:
Lease inception:
Early Buy-out Option:
Depreciation:
Lessor Tax Rate:
Rents:
Total Residual:
Fees Paid:
Guarantee)
Target yield:
Fund
Lessee’s Incremental Borrowing Rate:
Corporate Jet
$10,000,000.00
Single Investor Lease
120 months or 10 years
12/15/06
12/15/06
(84 months from Lease inception)
5 year MACRS Depreciation
Half year Convention
35%
Monthly in arrears
50% or $5,000,000.00
.5% or $ 50,000.00 (Portion for Residual
6.5% pre-tax Multiple Investment Sinking
6.0% Lessee’s comparable debt cost

Example of 467 Rent - Results
Lessor can structure various rent patterns within the Sec. 467 guidelines to minimize Lessee’s cost by increasing the value of tax benefits.
Rental Payment:
Level Payments 90/110 ____
$72,818.95 (1to 120) $66,232.47(1 to 60)
_
$6,831,083
$80,951.12 (61 to 120)
$7,206,012 EBO amount: (mo. 84)
If EBO Exercised:
PV of Rent + EBO
Implicit Cost :
95.02%
4.98%
94.54%
4.92%
If Lease goes to end of term and returns the aircraft to Lessor:
PV of min. lease payments 65.92%
IRR -2.65%
65.30%
-2.31%

Example of Lessor’s Tax Position
•Lessor Accounting :
Monthly Payment:
Implicit Rate:
PV of rents only :
•Lessor’s Classification:
$ 72,818.95
4.88%
69.29%
Operating Lease
•To re-classify as Direct Finance Lease:
•Lessor will require 3rd party residual Guarantee: $3,371,537.25
•PV of Minimum payments: 90.1%
•Impact on PT Yield and Lessor’s tax position and asset acquisition pattern
Half Year Mid Quarter AMT
•Pre-tax Yield
Convention
6.50%
•Impact to Lessor 0%
Convention
6.36%
.14%
2005 to 2010
4.88%
1.62%

Example of Lessor’s Taxable Income

Difference Between Accounting and Tax
Operating Lease Example
E. An example comparing book income to taxable income for an operating lease:
1.
Assume an operating lease for GAAP purposes and a true lease for income purposes.
a.
Lessor enters into a 60 month FMV lease of material handling equipment, having a cost of $1 million, monthly rent of $18,500, a residual of $200,000, and an implicit interest rate of 10%.
The first basic rent date is April 1, 20xx.
b.
There is no automatic transfer of ownership.
There is no bargain purchase option.
The equipment has an economic life of 10 years, therefore the lease term of 5 years is less than 75% of the economic life. The PV of the rents at the implicit rate of 10% is $878,000, which is less than 90% of the cost of the equipment. Therefore, the lease is an operating lease for financial reporting purposes.

Difference Between Accounting and Tax
•
•
•
•
•
•
•
Operating Lease Example (cont’d)
E. An example comparing book income to taxable income for an operating lease:
2.
Material handling equipment (generally) is five-year class property. MACRS depreciation rates (from the IRS table) are:
Year
1 st
2 nd
3 rd
4 th
5 th
6 th
%__
20.00
32.00
19.20
11.52
11.52
5.76

Difference Between Accounting and Tax
Operating Lease Example (cont’d)
3.
From the standpoint of the lessor, the lease will have the following incident of earnings:
Tax Books
Rental Income
1
$166,500
2
$222,000
Year ended December 31
3
$222,000
4 5 6
$222,000 $222,000 $55,500
Total
$1,110,000
Sale Proceeds 200,000 200,000
200,000
(33,500)
320,000
(98,000)
192,000
30,000
115,200
106,800
115,200 57,600
106,800 197,900
1,000,000
310,000
Depreciation Expense
Tax Income (Loss)
Tax Rate 40% (Combined
Federal & State Rate)
Tax Liability (Savings)
GAAP Books
Income before Tax
Tax Expense @ 40%
Net Income
Current Tax Liability
Deferred Tax Balance
40% 40%
($13,400) ($39,200)
46,500
18,600
$27,900
13,400
32,000
62,000
24,800
$37,200
39,200
96,000
40%
$12,000
62,000
24,800
$37,200
(12,000)
108,800
40%
$42,720
62,000
24,800
$37,200
(42,720)
90,880
40% 40%
$42,720 $79,160
62,000
24,800
$37,200
15,500
6,200
$9,300
(42,720) (79,160)
72,960 0
40%
$124,000
310,000
124,000
$186,000
(124,000)
0

Difference Between Accounting and Tax
Operating Lease Example (cont’d)
4.
A simple GAAP balance sheet presentation of the lease :
GAAP Books
Cash
Equipment under lease
Accumulated depreciation
1
$179,900
2
$441,100
3
$651,100
4
$830,380
1,000,000 1,000,000 1,000,000 1,000,000
(120,000) (280,000) (440,000) (600,000)
5
1,000,000
(760,000)
Total
$1,009,660 $1,186,000
Equipment under lease, net
Total Assets
880,000 720,000 560,000 400,000 240,000 0
$1,059,900 $1,161,100 $1,211,100 $1,230,380 $1,249,660 $1,186,000
0
0
Deferred Taxes
Stockholder’s Equity
Total Liabilities & Equity
192,000
867,900
192,000
969,100
166,400
1,044,700
125,400
1,104,980
84,400
1,165,260
0
1,186,000
$1,059,900 $1,161,100 $1,211,100 $1,230,380 $1,249,660 $1,186,000

Difference Between Accounting and Tax
Direct Finance Lease Example
From the standpoint of the lessor, the direct finance lease will have the following incident of earnings:
Taxable Income (Loss)
Tax Rate 40% (Combined
Federal & State rate)
(439,301)
40%
Current Tax Liability (Savings) (175,720)
GAAP Books
Income before Tax 73,253
Tax Expense @ 40% 29,301
Net Income $43,952
81,049 145,049
40%
32,420
84,247
33,699
$50,548
40%
58,020
67,398
26,959
$40,439
183,549
40%
73,420
48,738
19,495
$29,243
183,549
40%
73,420
28,074
11,230
$16,844
151,350
40%
60,540
3,534
1,414
$2,121
305,244
40%
122,098
305,244
122,098
$183,147
Current Tax Liability
Deferred Tax Balance
175,720
205,021
(32,420) (58,020) (73,420) (73,420) (60,540)
206,301 175,240 121,316 59,126 0
(122,098)
0

Difference Between Accounting and Tax
Direct Finance Lease Example
A simple GAAP balance sheet presentation of the lease:
GAAP Books 1 2
Year ended December 31
3 4 5
Cash
6
$196,508 $469,136 $690,566 $881,275 $1,071,984 $1,183,147
Gross Investment
Unearned Income
Residual
1,024,457 783,409
(231,991) (147,744)
100,000 100,000
542,360
(80,346)
100,000
301,311
(31,608)
100,000
60,262
(3,534)
100,000
0
0
0
Net Investment, Leases 892,466 735,664 562,014 369,703 156,728 0
Total Assets $1,088,974 $1,204,801 $1,252,580 $1,250,978 $1,228,712 $1,183,147
Deferred Taxes
Stockholder’s Equity
Total Liabilities & Equity
205,021
883,953
206,301
998,500
175,240
1,077,340
121,316
1,129,662
59,126
1,169,586
0
1,183,147
$1,088,974 $1,204,801 $1,252,580 $1,250,978 $1,228,712 $1,183,147

Q & A
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