Proper treatment of the buyout of a leased vehicle

Question

I have a client who files a Sch C for his distributorship business. He entered into a lease agreement with

Trans Lease and the initial lease agreement was in 2018 in the amount of $119K which was fully satisfied in January 2025. The original lease was set up as a capital lease recorded as an asset and related debt and the interest and depreciation were included in the tax returns. The original lease value has been fully depreciated since in 2023. In January 2025 the lease company offered him a buy-out of the truck for another $37K over 85 weekly payments. The client accepted the buyout lease and continues to make weekly lease payments broken down into principal and interest. My question is do I dispose of the original truck asset for $119K at zero selling price and then set up a new asset for the buy-out portion in the amount of $37K to record the asset for tax purposes and start depreciation again over another 5 years or the lease period ?

Your input is greatly appreciated. Thanks

TaxGuyBill · Accepted Answer

If I’m reading things correctly, it seems like the original lease should have been treated as an actual operating lease, not a capital lease.

At any rate, I wouldn’t enter the first asset as ‘sold’, but just remove it (or enter a disposition date and leave the sales price blank). For the recent event, it seems like he bought it. Depreciate it over the usual 5 years for a vehicle (unless it a specialized vehicle with a different Recovery Period).

AnmarieA · Answer

TaxGuyBill thank you for your input.I was not this client’s tax preparer when the vehicle was originally purchased in 2018when it was set up as a capital lease. The client gave me a copy of the original lease, and it clearly states thebuyout at the end of the 6-year term and the buyout price was determined. The lease qualified as a “ROU” right of use asset as the lease holder was fully responsible for all the upkeep,and operationof the vehicle. The lease could not be cancelled either. I can understand why the previous accountant set the truck up as a depreciable asset, but they could have set it up as an asset to record the debt but not depreciate it and record the lease payments as rent. I am not trying to debate the past treatment as I cannot change that, and the asset was fully depreciated as of 2023 when I started doing their taxes in 2024. At the end of the day the expense was recognized in the return whether it was classified as depreciation or rent expense, it is more of a timing issue for the client and IRS historically, but I will correct it moving forward. .I am happy that you confirmed that I set up the buyout value as an asset and depreciate it over the normal 5-year life.I will also remove the first recording of the vehicle.Thanks again for your feedback.

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