An operating lease is a lease which allows someone the right to use property in the short term, without any ownership rights. Some examples of operating leases include leases of commercial real estate by business owners, leasing of aircraft by an airline, or the leasing of industrial equipment by manufacturers. There are a number of reasons to opt for an operating lease in contrast with other types of lease or outright ownership.
With an operating lease, the term of the lease is considerably shorter than the overall life expectancy of the property being leased. This type of lease is ideal for people who want to be able to use property, but do not want to own it. Ownership comes with a number of responsibilities and risks which may not be acceptable. Leases provide a great deal more flexibility, which can be highly beneficial, and a well structured lease can cut down on the expenses of running a business.
In a capital lease, by contrast, the lease comes with some ownership rights. A number of criteria can cause a lease to be classified as a capital lease. If the length of the lease exceeds 75% of the expected life of the property or the value of the lease exceeds 90% of the value, it is a capital lease. Likewise, if the lease includes an option to buy at a rate below market value or the ownership of the property is transferred at the end of the lease, it is a capital lease.
Capital and operating leases are treated differently on financial balance sheets, tax documents, and other financial information. This makes the distinction between the two important, and in many regions, the distinction is clearly defined under the law to make sure that people classify their leases appropriately. For publicly traded companies, keeping financial sheets honest and reflective of the company's true situation is especially important.
The terms of an operating lease can vary considerably. It is important to evaluate the lease agreement with care to confirm that the terms are reasonable, and to ensure that they are fully understood. If people want to dispute the terms or they are concerned about the wording on a lease, they should voice these issues before the lease is signed and asked to have them addressed. Once an operating lease is signed, it is much more difficult to contest the terms, and people may end up in uncomfortable situations as a result.
