The Most Common Questions About Tax-Exempt Municipal Leasing … And The Answers

Real Lease is here to answer all your questions. For your benefit, we've compiled a list of the most commonly asked questions... and the answers.

What is a municipal or tax-exempt lease?

A municipal or tax-exempt lease agreement allows a political subdivision to use its annual revenues to make payments for any type of essential use equipment or facilities. This structure is an alternative to purchasing an asset with cash, acquiring its use for a period of time through a true lease, or issuing bonds.

The term ‘tax-exempt’ or ‘municipal lease’ refers to the interest earnings paid to the lessor of a properly structured and documented lease, being exempt from federal income tax. The same tax laws that enable a municipal bond to carry a tax-exempt rate apply to a municipal lease. Only municipalities or qualified political subdivisions can qualify for this type of agreement. Because the lessor does not pay federal income tax on the interest earned, the tax-exempt lease carries a much lower interest rate than other types of leases and installment loans. This significantly lowers the cost of financing to the borrower.

While municipal leases are documented as a lease, they have characteristics similar to a loan. The lessee owns the equipment at the end of the lease, and the lease can be paid-off early. These financing agreements are structured as a lease to accommodate the fiscal funding restrictions of political subdivisions. In most cases, the obligation terminates if the lessee fails to appropriate funds to make the renewal year's lease payments. Because of this provision, neither the lease nor the lease payments are considered debt (in most states).

What types of entities qualify for a municipal or tax-exempt lease?

For the lease to qualify for the interest exclusion, a lessee under a tax-exempt lease must be a state or possession of the U.S., the District of Columbia, or a political subdivision thereof. This may include state entities such as school districts, special purpose districts (fire, parks, utility, water, etc.), hospitals, agencies, authorities, boards and commissions. To be qualified, a governmental entity must possess one of three characteristics of a government, the power of eminent domain, police power, or the power to levy taxes.

The fact that an agency is financially supported by government funds or is "tax-exempt" does not always ensure qualification. Additionally, some provisions within the tax code allow organizations that provide essential services on behalf of political subdivisions, such as Volunteer Fire Departments, rescue squads, EMS, etc., to issue tax-exempt debt with limitations.

Non-profit organizations created under Section 501(c)(3) of the Internal Revenue Code do not qualify directly as issuers of tax-exempt obligations but may be eligible with a sponsoring governmental unit. Non-profit organizations that may benefit from tax-exempt leasing include:

  • Health Care (Hospitals, Clinics, Nursing Homes, Life Care Centers)
  • Education (Colleges and Universities, Preparatory Schools)
  • Museums
  • Research Centers

Does a Volunteer Fire Department qualify for the same rate as a City, County or District?

Yes, on trucks and stations. Per Section 150 (e) of the IRS Code, independent fire companies qualify for tax-exempt rates on their purchase of fire trucks or fire station construction (new or remodel). However, equipment such as SCBAs, turnout gear, rescue tools, compressors, ambulances, and buildings not used for fire fighting purposes, would not qualify. They do qualify for our nonprofit rates, which are lower than standard commercial rates.

Why lease the equipment?

Tax-exempt leasing is one of the simplest and most successful ways to purchase essential equipment and facilities. In addition to qualifying for low interest rates, municipalities can conserve their cash while acquiring the equipment and facilities necessary for their day-to-day operation. Entering into a municipal lease may also be more cost effective because political subdivisions can purchase equipment or facilities at today’s prices, not next year’s price increase. This is in addition to the annual savings realized through decreased maintenance costs.

There are laws in all 50 states that restrict the ability of municipalities to borrow money. There are, however, very few restrictions on the ability of municipalities to enter into a lease. Leases represent a year-to-year commitment on the part of a municipality to make lease payments, not a commitment to pay debt service. In other words, leases are not considered debt and, therefore not subject to the limitations placed on debt by state and local laws.

Is leasing easy?

Lease purchasing is much easier and quicker than bonding. A lease agreement can be completed in a matter of days, whereas a bond may require months or years of planning and execution; and still may be more expensive.

What is the difference between a municipal lease purchase and a commercial/rental lease?

To a governmental lessee, the difference between a municipal lease and a commercial or rental lease is who owns or will own the asset. Most commercial leases are rental agreements allowing the lessee to use the lessors’ property, charging them for the use of the equipment. The lessee makes payments but does not build equity in the equipment and may or may not have an option to purchase the equipment/property. There may be a high residual value set at the end of the lease with a term much shorter than the useful life of the asset.

With a municipal lease, the lessor provides money to the lessee to purchase property and charges the lessee interest for the use of that money. The term of a municipal lease generally can be as long as the lessee desires, up to the equipment’s approximate useful life. The lessee takes title to the property and the lessor takes a security interest in the property as collateral. The lessee builds equity with each payment and has the option to purchase the property throughout the lease. Additionally, a municipal lease is normally subject to the annual appropriations of the lessee and is financed at a low tax-exempt rate.

Who owns the equipment under a tax-exempt lease and who is responsible for maintenance, insurance and taxes?

The lessee takes title to the equipment or deed to the property at the beginning of the lease. The lessor takes a security interest in the equipment or property as collateral. The lessee is responsible for the use, maintenance and insuring of the equipment or property.

What is a non-appropriation or funding out clause?

The non-appropriation clause enables the lessee to account for the lease obligation as a current expense instead of debt. A non-appropriation clause enables the lessee to terminate the lease agreement at the end of the current appropriation period without further obligation or penalty. This can be done only in cases where the lessee is unable to obtain funding for future payment obligations on the lease. Typically, the clause will contain a 'best efforts' requirement whereby the lessee must use its best efforts to obtain the necessary appropriation for the lease payments.

What can be financed on a tax-exempt basis?

Any personal property equipment or real property essential to the operations of the municipality. As you may have guessed, this is quite a large list.

Am I limited to certain types of equipment?

No. We will finance various types of "essential use" equipment from copiers to fire trucks!

What do you mean by tax-exempt financing, our organization is already tax-exempt?

By tax-exempt, we mean the interest earnings on the financing are exempt from federal income tax per Section 103 of the Internal Revenue Code. Because we do not pay income tax on the interest earned, the savings are passed on to the lessee in the form of lower interest rates. In contrast, a ‘tax certificate’ or ‘sales tax exemption certificate’ received by many nonprofit entities, refers to a ‘sales tax exemption’ and/or exemption from paying federal income tax, not the ability to finance equipment tax-exempt.