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What Is an Operating Lease?

Examples of operating leases, which allow tenants the right to use property for a short term, include leases of commercial buildings.
Operating leases can cover the short-term use of business equipment, as well as office and production spaces.
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  • Written By: Mary McMahon
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  • Last Modified Date: 26 September 2014
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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.

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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.

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anon296721
Post 3

If I vacate the property but don't end the lease can I write the remaining lease to expire in the current period?

write79
Post 2

I understand the difference between a capital vs. an operating lease. What I'm confused about is the life expectancy of a property. I didn't know that property could have a life expectancy.

What are the factors that determine what the life expectancy is? I was about to sign an operating lease, but I want to make sure it's the right choice. I don't want to sign it if it's really a capital lease that I should be getting.

upnorth31
Post 1

I had no idea there were different kinds of leases. I'm in the beginning stages of opening up my own business, and figured that leasing a building was the way to go. I knew for sure that I couldn't afford to buy one.

Then people started asking me what kind of lease I was looking for and I had no idea what they were talking about. I didn't know what the difference was between a capital lease vs. an operating lease! Thanks for the information. It has been very useful.

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