When expanding businesses in India want to acquire real estate, they have two reliable options: purchasing a mortgage loan or rent-to-purchase. This is also known as a capital or financial lease. But how does a financial lease work, and are there any limitations involved in this leasing arrangement? Financial leasing, also known as capital leasing, is a common practice for businesses looking to expand economically. This concept, however, is not limited to just real estate; businesses can rent to own any asset, such as machinery or furniture. This article will explore the meaning, benefits, limitations, and key features of a financial lease.
See also: Lease: Meaning and types of lease
What is financial lease in real estate?
A financial lease in real estate is a type of lease agreement that allows the tenant to purchase the property at the end of the lease term. This type of lease is commonly used in commercial real estate transactions.
What are the key features of a financial lease?
Lease duration
- Ranges from 5 to 20 years
- Provides a long-term solution for property needs
Purchase options
- Lessee can buy the property at a predetermined price
- Provides an opportunity for long-term ownership
Tax depreciation
- Lessee can claim tax depreciation on the property
- Results in significant tax savings for businesses
Risks and rewards
- Transfers both risks and rewards of ownership to the lessee
- Lessee is responsible for maintenance, insurance, and all other costs associated with the property
Non-cancellable agreement
- Terms and conditions cannot be changed or terminated by the lessor without the lessee’s consent
Amortisation
- Lessee is responsible for the amortization of the property
- The cost of the property is spread out over the lease term, making it more affordable for businesses.
What are the advantages of financial lease?
- No large upfront payments are required for financial leases.
- Lease payments can be deducted from taxable income, reducing business tax liability.
- Financial leases offer flexible terms and conditions, allowing businesses to negotiate favorable duration and buyout options.
- During the lease term, the lessee has the right to use and benefit from the property, while the lessor retains legal ownership.
- Fixed monthly payments make it easier for businesses to budget and plan their finances.
What are the disadvantages of financial lease?
- Financial leases can be long-term agreements that limit a business’s ability to relocate or upgrade their real estate.
- The lessee is responsible for maintenance and repairs, which can add additional costs and burdens.
- Lessees may face limitations on making significant modifications or alterations to the leased property without the lessor’s approval.
- Unlike a mortgage, financial lease agreements do not provide the lessee with any equity or ownership rights in the property.
- Financial leases may result in higher total costs compared to purchasing the property outright over the long term.
How are real estate financial leases taxed in India?
Financial leases are a type of rental income and are taxed according to the lessor’s income tax rates. For individuals and Hindu Undivided Families (HUFs), the income tax rates range from 5% to 30% based on the income slab. Companies have a flat tax rate of 30%. Depreciation allowances also depend on the type of property, such as residential or commercial. Residential properties have a depreciation rate of 10% per annum, while commercial properties have a rate of 20% per annum. In India, real estate financial leases are subject to Goods and Services Tax (GST) of 18% for commercial leasing. However, residential properties are exempt from GST.
FAQs
Can the lessee buy the property at the end of the lease term?
Yes, the lessee can buy the property at a predetermined price at the end of the lease term.
Who is responsible for maintenance and repairs?
The lessee is responsible for maintenance and repairs, which can add additional costs and burdens.
Are lease payments tax-deductible?
Yes, lease payments can be deducted from taxable income, reducing business tax liability.
Can lessees make significant modifications or alterations to the leased property?
Lessees may face limitations on making significant modifications or alterations to the leased property without the lessor's approval.
How are real estate financial leases taxed in India?
Real estate financial leases are subject to Goods and Services Tax (GST) of 18% for commercial leasing, while residential properties are exempt from GST. Depreciation allowances also depend on the type of property and are taxed according to the lessor's income tax rates.
Can a financial lease be terminated before the end of the lease term?
A financial lease is a non-cancellable agreement, meaning that the terms and conditions cannot be changed or terminated by the lessor without the lessee's consent.
What is the difference between a financial lease and an operating lease?
A financial lease is a lease agreement that allows businesses to rent an asset, such as real estate, for a long-term period with the option to purchase the asset at the end of the lease term. An operating lease, on the other hand, is a short-term lease agreement that allows businesses to rent an asset without the option to purchase it at the end of the lease term.
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Khushi Jha, a graduate in history and political science from the University of Delhi, doesn’t restrict herself to a single domain. Her passion for writing has led her to explore a wide spectrum of topics, ranging from fashion, health and lifestyle to technology, real estate and finance. She has written for platforms like TheVoiceOfWoman, Techsunk, Fitmist and Menskool, among others. When free, she enjoys reading books, including fiction, history and geopolitics.
