Lease financing is generally provided as an operating lease, sometimes called a true or tax lease. In an operating lease, the lessor is the bona fide owner of the aircraft, which is why the lessor is entitled to the depreciation for tax purposes and also why the lessor bears the residual risk that the aircraft’s value will decline more than expected over time. In a capital lease, on the other hand, the lease is deemed for accounting and tax purposes as a form of ownership by the lessee. That’s because the capital lease (like a loan) provides a way of financing the lessee’s purchase of the aircraft. For example, if at the end of the lease the lessee has the right to take title to the aircraft for one dollar, the lessee has in effect purchased the aircraft in installments by leasing it over time. A conditional sale contract, as defined in the Federal Aviation Act, can be a capital lease.
IRS and accounting rules regarding leases, however, are not the same. This difference has permitted financial institutions to structure leases which, for tax purposes, are loans, while for financial accounting rules they are operating leases. Such leases are called synthetic and are popular with aircraft buyers who want the benefits of tax depreciation without having to show the aircraft as an asset or the lease as a liability for accounting purposes.
A synthetic lease often requires a complicated structure, frequently involving a special-purpose entity. For accounting purposes, the “lessee” does not book the aircraft as an asset or the lease as a liability on its balance sheet; instead, the lease is reflected as an expense on the income statement. For tax purposes, on the other hand, the “lessee” is deemed to have sufficient benefits and burdens of ownership to be considered the “owner” of the aircraft, and the “lease” is treated as a loan. The result is a classic case of owning your cake and leasing it, too.
Small Aircraft Exemption Web Resource
IRS Commercial Transportation Taxes for Part 91 Flights