What Is A TRAC Lease?
If you’ve been searching the internet for information about equipment leasing, you’ve probably run into a wall of industry jargon. Between captive lessors, capital leases, equipment financing agreements, and references to Section 179, the terminology can get pretty opaque. This is especially true when it comes to TRAC leases.
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What Are They?
TRAC stands for Terminal Rental Adjustment Clause. Not very helpful? Let’s pull it apart a bit more. But first I’m going to throw another term at you.
When you lease a product, the residual is the amount that you can buy the product for at the end of your lease. Typically, the higher your residual, the lower your monthly payments. So in leases that are designed to serve more or less as equipment loans, your residual is often only a dollar—you’re effectively paying off the full cost of the equipment (plus interest) over the length of the term.
A TRAC lease adds some layers of flexibility to this arrangement. How much flexibility depends on the lessor, but usually a TRAC lease allows you to negotiate your residual and monthly payments. If you prefer to have a large residual and lower monthly payments, you can do that. Or, if you’d prefer to have higher monthly payments and a lower residual, you can do that too.
Additionally, some TRAC leases allow for flexibility in term lengths. After a minimum term length, the lessee–that’s you–may terminate the lease, at which point the equipment will be purchased or sold. Alternately, you can continue your lease with corresponding adjustments to your monthly payments and residual.
Traditionally TRAC leases have been considered operating leases, meaning that the title remains with the lessee until the time of sale. Upcoming changes to lease laws are tightening the definition of an operating lease, so be sure to check with a CPA to understand how a TRAC lease will affect your books.
What Happens At The End Of A TRAC Lease?
If you want to purchase the equipment, you simply pay the agreed-upon residual. In this regard, TRAC leases are pretty similar to FMV leases (except the residual is a negotiated value rather than the item’s “fair market value”).
Where it gets a little weird is if you decide not to buy.
Let’s say that, at the end of your TRAC lease, you end up with a $10,000 residual on the vehicle you leased. You return the vehicle to the bank, at which point the bank sells it to a third party. If the lessor manages to sell it for more than the residual value, the lessor returns the difference to you, minus any costs associated with selling it. Likewise, if they sell it for less than the residual value, you reimburse the lessor for the loss.
So if it sells for $12,000, the lessor will owe you $2,000. If it sells for $9,000, you’ll owe the lessor $1,000.
Who Uses TRAC Leases?
TRAC leases are most commonly used to acquire vehicles like trucks, forklifts, buses, and trailers.
Could You Benefit From One?
It depends on your needs and your willingness to negotiate. Typically, leases like these are better for lessees that don’t want to own their equipment and probably don’t want to buy it at the end of their term.
So why not pay as little as possible each month and be left with a huge residual?
Remember that you are ultimately responsible for paying the difference between the residual and what the equipment actually sells for. Chances are the lessor won’t let you negotiate a completely unrealistic rate, but you’ll still want to do some planning and research to figure out how much the product will likely be worth at the end of your term.