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Frequently Asked Questions

What is a municipal or tax-exempt lease?

A municipal or tax-exempt lease agreement allows a political subdivision to use its annual revenues to make payments for any type of essential use equipment or facilities. This structure is an alternative to purchasing an asset with cash, acquiring its use for a period of time through a true lease, or issuing bonds.

The term ‘tax-exempt’ or ‘municipal lease’ refers to the interest earnings paid to the lessor of a properly structured and documented lease, being exempt from federal income tax. The same tax laws that enable a municipal bond to carry a tax-exempt rate apply to a municipal lease. Only municipalities or qualified political subdivisions can qualify for this type of agreement. Because the lessor does not pay federal income tax on the interest earned, the tax-exempt lease carries a much lower interest rate than other types of leases and installment loans. This significantly lowers the cost of financing to the borrower.

While municipal leases are documented as a lease, they have characteristics similar to a loan. The lessee owns the equipment at the end of the lease, and the lease can be paid-off early. These financing agreements are structured as a lease to accommodate the fiscal funding restrictions of political subdivisions. In most cases, the obligation terminates if the lessee fails to appropriate funds to make the renewal year's lease payments. Because of this provision, neither the lease nor the lease payments are considered debt (in most states).

What is a non-appropriation clause and why is it needed?

With a lease-purchase Agreement, a non-appropriation clause enables the lessee to account for the lease obligation as a current expense instead of debt and to terminate the lease agreement at the end of the current appropriation period without further obligation or penalty. This may be done only in cases where the lessee was unable to obtain funding for future payment obligations on the lease. Typically, the clause will contain a 'best efforts' requirement whereby the lessee must use its best efforts to obtain the necessary appropriation for the lease payments.

What types of entities qualify for a municipal or tax-exempt lease?

For the lease to qualify for the interest exclusion, a lessee under a tax-exempt lease must be a state or possession of the U.S., the District of Columbia, or a political subdivision thereof. This may include state entities such as school districts, special purpose districts (fire, parks, utility, water, etc.), hospitals, agencies, authorities, boards and commissions. To be qualified, a governmental entity must possess one of three characteristics of a government, the power of eminent domain, police power, or the power to levy taxes.

The fact that an agency is financially supported by government funds or is "tax-exempt" does not always ensure qualification. Additionally, some provisions within the tax code allow organizations that provide essential services on behalf of political subdivisions, such as Volunteer Fire Departments, rescue squads, EMS, etc., to issue tax-exempt debt with limitations.

Who owns the equipment under a tax-exempt municipal lease and how is the equipment titled?

Title may either be retained by the lessor until all payments have been received or may be granted to the lessee at lease inception. In the case of the latter, the obligation is secured by a 'perfected' first security lien on the equipment. In most cases it is preferable to pass title up front to avoid any potential tax issues.

Why lease the equipment?

Tax-exempt leasing is one of the simplest and most successful ways to purchase essential equipment and facilities. In addition to qualifying for low interest rates, municipalities can conserve their cash while acquiring the equipment and facilities necessary for their day-to-day operation. Entering into a municipal lease may also be more cost effective because political subdivisions can purchase equipment or facilities at today’s prices, not next year’s price increase. This is in addition to the annual savings realized through decreased maintenance costs.

There are laws in all 50 states that restrict the ability of municipalities to borrow money. There are, however, very few restrictions on the ability of municipalities to enter into a lease. Leases represent a year-to-year commitment on the part of a municipality to make lease payments, not a commitment to pay debt service. In other words, leases are not considered debt and, therefore not subject to the limitations placed on debt by state and local laws.

Is leasing easy?

We take great pride in ensuring your leasing experience is easy.  Lease purchasing is much easier and quicker than bonding. A lease agreement can be completed in a matter of days, whereas a bond may require months or years of planning and execution; and still may be more expensive.

What can be financed on a tax-exempt basis?

Any personal property equipment or real property essential to the operations of the municipality.

What factors should be considered in deciding whether or not to use a tax-exempt lease?

When acquiring financing for any asset acquisition decision, the principal financial objective is to obtain the use of the asset for the lowest possible cost, while at the same time, staying within budget requirements and availability. Some key points to consider would be:

  • Availability of cash at the time of procurement
  • Competing demands on capital resources
  • Essentiality of the asset to the basic functions of the entity
  • Useful life of the asset
  • Desirability of matching costs and benefits over time