7893 / What is a terminal rental adjustment clause in a motor vehicle operating lease? How does a terminal rental adjustment clause impact characterization of an equipment leasing arrangement as a sale or a lease?

Terminal rental adjustment clauses will be disregarded for purposes of lease characterization in the case of a qualified motor vehicle operating agreement.¹ A terminal rental adjustment clause is a provision that calls for an additional payment by the lessee if the lessor is not able to obtain a stated amount upon the sale or other disposition of the property at the end of the lease term or a payment by the lessor if the lessor is able to obtain more than the stated amount. Terminal rental adjustment clauses also include provisions requiring a “lessee who is a dealer in motor vehicles to purchase the motor vehicles at a predetermined price and then resell such vehicle where such provision achieves substantially the same results.”²

A qualified motor vehicle operating agreement is an agreement with respect to a motor vehicle (including a trailer) that meets the following requirements: (1) the sum of the lessor’s recourse liability with regard to the lease and the net fair market value of property pledged as security for the leased property (other than property subject to the lease or financed directly or indirectly by property subject to the lease) must be greater than or equal to the amount borrowed to acquire the property subject to the lease, (2) the lessee must supply a sworn statement that the lessee intends for more than 50 percent of the use of the property to be in the trade or business of the lessee and that the lessee is aware he or she will not be treated as owner of the property for federal income tax purposes, and (3) the lessor must not have knowledge that the lessee’s sworn statement is false.³

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1. IRC § 7701(h)(1).

2. IRC § 7701(h)(3).