What TRAC Leases Are, How They Work, & When They’re The Right Choice For Your Small Business
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.
If you’ve ever wondered what the TRAC lease is, how it works, or even just what the acronym stands for, you’ve come to the right place.
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What TRAC Leases Are
A TRAC lease, or terminal rental clause agreement lease, is a motor vehicle and trailer lease that allows adjustments to payment terms, lengths, and residuals while the lease is active.
To help understand how a TRAC lease is different, let’s talk about how a vehicle lease normally works. A percentage of the cost of the equipment (a vehicle or trailer in the case) is broken up into equal payments over the length of the lease, plus applicable interest. At the end of the lease, the cost of the vehicle that was not covered by the monthly payments is left over at the end. This amount is called the residual.
Generally speaking, leases that end in a large residual are used to rent equipment while leases that leave a small residual, sometimes as small as $1, are used to buy equipment.
TRAC leases play with that formula a bit.
How TRAC Leases Work
A TRAC lease adds some layers of flexibility to the normal leasing 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. If you’d prefer to have higher monthly payments and a lower residual, you can do that too. The amount that you agree to pay per month is called the reserve for depreciation.
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 by the lessor, who has retained the title throughout the lease. Proceeds from the sale are applied to the remaining balance. Depending on how much you’ve paid into your reserve for depreciation and how much the vehicle has depreciated in value, you may either owe a balance to or receive a refund from your lessor.
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. Recent changes to lease laws seem to now consider TRAC leases capital leases for tax purposes even though they retain elements of an operating lease with regard to title holding.
Typical TRAC Lease Rates & Fees
TRAC leases typically cover 100% of the vehicle’s costs. Remember that your monthly payment is your reserve for depreciation and that this is a number you negotiate with your lessor, which makes it very difficult to anticipate exact rates, though somewhere between 10% and 20% is likely. In addition to your reserve for depreciation, your lessor may charge an administrative fee.
Finally, when you terminate your lease, you may be responsible for the residual depending on how much your vehicle sells for if you choose not to buy it.
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. Some lessors will even give you the option of selling the vehicle instead to a third party of your choice.
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.
Other Types Of TRAC Leases
Beyond the standard configuration, TRAC leases come in a few other forms.
Split TRAC Lease
A split TRAC lease is nearly identical to a basic TRAC lease, but offers some additional protection to lessees. With a split TRAC lease, your liability is reduced. That is to say, if you have a shortfall after the sale of the vehicle, the maximum amount you owe your lessor will be capped. This can protect you from volatility in the resale market.
Zero TRAC Lease
A zero TRAC lease modifies the amortization schedule so that it zeroes out by the end of the lease, leaving behind no residual and granting full ownership of the vehicle, provided of course that you’re not using the TRAC lease early termination option. This is a good option if you think you’ll want to own the vehicle after the lease expires.
Modified TRAC Lease
With the recent changes in lease accounting standards, TRAC leases have–at least for tax purposes–become reclassified as capital leases rather than operating leases. This means the vehicle appears on your balance sheet as an asset. Modified TRAC leases, however, are classified as operating leases for tax purposes, meaning that they’re considered a business expense rather than an asset.
When A TRAC Lease Is Right For Your Small Business
The nature of TRAC leases greatly limits what they can be used for: they’re for motor vehicles and trailers, and that’s it. If you need a vehicle or a trailer and aren’t looking to buy one outright, a TRAC lease is one of the more versatile ways to finance one. When you factor in TRAC lease variations like modified TRAC leases, you can have tremendous control over the terms, conditions, and tax classification of your lease.
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.
FAQs About TRAC Leases
Your Next Steps
By now you probably have an idea of whether a TRAC lease could work for your business. Where should you go from here?
If A TRAC Lease Is Right For Your Business
If a TRAC lease sounds like a good fit for your business, you’ll want to do three things:
- Have A Vehicle Make & Model In Mind: While policies vary between lessors, it’s never a bad idea to have a good idea of the equipment you’re looking for in advance.
- Find A Lessor That Offers TRAC Leases: TRAC leases are fairly common, but aren’t offered by all equipment financers. You can search for the keyword online to find them, or take a look at our list of favorite equipment financers, some of whom offer TRAC leases.
- Get Relevant Documents Ready: Your lease application will go a lot more smoothly if you have commonly required documentation handy. This includes things like identification, tax returns, and bank statements.