FMV Lease vs $1 Buyout Lease: Which Equipment Lease Fits Your Business?
Compare fair market value leases, $1 buyout leases and 10 percent purchase options on payments, ownership, taxes and end-of-term risk, with a worked example.
Choose a $1 buyout lease if you plan to keep the equipment for its whole useful life and want ownership at the end. Choose a fair market value (FMV) lease if the equipment loses value or becomes outdated quickly and you prefer lower payments and the freedom to return or upgrade it. The 10 percent purchase option lease sits between the two. The right choice depends on how long you will use the asset, how you want it treated for tax and accounting, and how comfortable you are with uncertainty at the end of the term.
How each structure works
Fair market value lease. The lessor owns the equipment throughout the term. Payments are based on the difference between the cost and the expected residual value. At the end you usually have three options: return the equipment, renew the lease, or buy it at its then-current fair market value. The price is not known in advance, though the contract defines how it is determined.
$1 buyout lease (also called a capital lease, finance lease or dollar-out lease). Payments cover almost the full price and interest. At the end you buy the equipment for $1 or a nominal amount. Economically, it behaves like a loan with the lessor holding title until the end.
10 percent purchase option lease. The contract sets a fixed purchase price, often described as a percentage of original cost, such as 10 percent. Payments are lower than a $1 buyout but higher than an FMV lease. Some versions are labeled differently, so read how the option is defined.
Fixed purchase option or "split TRAC" style structures. For commercial vehicles, a terminal rental adjustment clause (TRAC) lease sets a stated residual. Depending on the clause, the lessee may share in gains or cover shortfalls. Because the residual risk can shift to you, review it with a professional.
Side-by-side comparison
| Feature | FMV lease | $1 buyout lease | 10% purchase option |
|---|---|---|---|
| Monthly payment | Lowest | Highest | In between |
| Ownership at end | Only if you buy at market value | Yes, for $1 | Yes, if you pay the option price |
| End-of-term price certainty | No, determined at that time | Yes | Yes |
| Best for | Fast-depreciating or fast-obsolete equipment | Equipment you will keep for years | Buyers wanting some certainty with lower payments |
| Usual tax treatment | Often treated as a lease with deductible payments | Often treated as a purchase for tax purposes | Depends on terms |
| Risk | Return conditions, renewal terms and market-value dispute | Paying for equipment you may not use for the full term | Option price above actual value |
Worked example
Take a $60,000 piece of equipment financed over 48 months at an implied 8% rate (illustrative numbers). The monthly rate is 8% / 12, which is 0.006667. The factor for 48 months is 1 - (1.006667)^-48, about 0.2731.
- $1 buyout: payment = 60,000 x 0.006667 / 0.2731, about $1,465 a month. Total paid is about $70,320. You own the equipment after the last payment.
- FMV with a 25% residual ($15,000): present value of the residual is about 15,000 x (1 - 0.2731) = about $10,904, using the discount factor 0.7269. Amount financed through payments is about $49,096, so the payment is about $1,198 a month. Total paid is about $57,504. At the end, to keep the machine you pay its market value, which might be above or below $15,000.
The FMV lease saves about $267 a month, or about $12,800 over the term. If you buy the equipment at the end for $15,000, your total becomes about $72,504, which is about $2,200 more than the $1 buyout. If market value turns out to be $9,000, you pay less. If it is $22,000, you pay more. The lease only wins clearly if you return the equipment or if you buy at or below the assumed residual.
Tax and accounting considerations
For tax purposes, the IRS looks at the substance of an agreement, not its label. A lease with a nominal purchase option is commonly treated as a conditional sale, which can make the lessee the tax owner and open the door to depreciation deductions such as Section 179 or bonus depreciation. An FMV lease is more often treated as a true lease, with payments deducted as rent. The details are in your contract, so ask your CPA to review it. Our guide to Section 179 and bonus depreciation for equipment covers the basics.
For financial reporting, ASC 842 requires most lessees to record leases longer than 12 months on the balance sheet as a right-of-use asset and a lease liability, whether the lease is classified as operating or finance. Classification as a finance lease is triggered by tests such as ownership transfer, a purchase option the lessee is reasonably certain to exercise, a lease term that covers a major part of the asset's economic life, or present value of payments substantially all of the asset's fair value. Private companies using ASC 842 should confirm the details with their accountant. Small businesses that use cash-basis tax accounting may not need to think about this, but lenders reading your financial statements will.
How to decide
- How long will you use it? If you will use the machine well past the term, a $1 buyout is usually simpler.
- How fast does it lose value? Computers, medical imaging software and similar assets argue for FMV or short terms.
- What is your cash flow? If the lower FMV payment is needed to keep cash flow healthy, accept the end-of-term uncertainty.
- What are the tax goals? Ask your CPA whether ownership and depreciation or rental deductions suit your situation.
- Who handles the equipment at the end? Returning equipment means logistics and condition requirements.
Contract points that change the math
- How fair market value is determined, and who decides if you disagree.
- Notice windows for return or renewal, often 90 to 180 days before the end.
- Automatic renewal clauses and what the renewal payment is.
- Return conditions, such as normal wear and tear definitions and refurbishment charges.
- Whether there is an early buyout option and how it is priced.
Frequently asked questions
Is a $1 buyout lease really a lease?
Legally it is documented as one, but economically it is financing. That is why it is often treated as a purchase for tax and accounting purposes.
Can I convert an FMV lease into a $1 buyout later?
Not usually without renegotiating. You can often buy the equipment before the end under the contract's early purchase terms, if available.
Which is cheaper overall?
It depends on what the equipment is worth at the end. FMV is cheaper if you return it or if its value ends up at or below the assumed residual; a $1 buyout is cheaper if you plan to keep the equipment and its market value would be higher than the residual.
Sources and further reading
- Internal Revenue Service — guidance on whether an agreement is treated as a lease or sale.
- Financial Accounting Standards Board — ASC 842 lease accounting.
- Equipment Leasing and Finance Association — lease structure definitions.
