Key Terms
Lessor: The lessor is the owner of the vehicle and is the party leasing it to a business or to a person. The lessor receives payment for lending out their vehicle.
Lessee: The lessee is the person or business that is leasing the vehicle from the lessor. The lessee pays for using the vehicle.
Typical length of a lease
The typical vehicle lease is between 2 and 4 years, while the typical loan term for a purchase is between 3 and 7 years.[1]
What to Include (11 items)
1. Identify the Parties
Identifying information about the lessor and lessee is included to establish legal enforceability. Without this, a court would never know who is responsible for which elements of the contract.
2. Identify the Vehicle
The vehicle must be identified in the lease including: make, model, color, plate and VIN numbers. The vehicle’s odometer reading should be included. An accurate record of the vehicle mileage must be kept in order to track any excess mileage.
3. Costs and Payments
In addition to the monthly payment amount and number of months it must be paid to the lessor, this section of the lease clearly spells out all of the costs, fees, and taxes that the lessee is responsible for.
4. Mileage Limits and Fees
Placing mileage limits in the lease serves to preserve the vehicle’s residual value when the lease ends. If the lessee exceeds the limit, an additional fee per mile is assessed to compensate the lessor for the additional depreciation of their asset.
5. Use and Maintenance Requirements
If there are any limits on specific vehicle use, they should be detailed for the lessee. Additionally, the lessee must be made aware that they are responsible for maintaining the vehicle for the term of the lease.
6. Insurance Requirements
The lessee is normally required to insure the vehicle for amounts determined by the lessor, which usually include full replacement in the event of theft or complete loss.
7. Purchase Option
Some leases allow the lessee to purchase the vehicle upon lease termination. This is not a requirement, and will depend on the needs of the lessor.
8. Termination Options
All leases terminate at some point. Most leases include options for early termination in addition to the scheduled end of the lease.
9. Excess Wear and Tear
The lease should make clear what happens if the vehicle is subject to excess wear and tear. The vehicle will naturally degrade over the life of the lease but the lessee will be responsible for repairing anything beyond “normal” wear and tear.
10. Warranty
If the vehicle is new, it will likely be covered by a manufacturer’s warranty of some kind. If the vehicle is used, it may not be covered by a warranty at all.
11. Disclosures
Some states require the lease to include specific language in the form of disclosures. For example: in California, leases must disclose to the lessee that there is no “cooling off period” like there is with a purchase.
Sales Tax on Leased Vehicles
In most states, the lessee is only responsible for paying sales tax on any down payment, and on monthly payments as they are made. In these states, lessees pay tax on the portion of the vehicle that they pay to use, not on the vehicle’s full value.
Some states require that the lessee pay sales tax upfront on the full value of the vehicle as if it were being sold. For the lessee, this means a higher overall cost to lease and can cause the lessee to pay sales tax again if the vehicle is purchased at the end of the lease.
Deferring Upfront Sales Tax
In some cases, the lessor may be willing to pay the sales tax upfront for the lessee and then roll its repayment into the monthly lease payments. However, the lessee will most likely pay interest on this service in the form of an increased rental cost.[2]
Sales Tax on Vehicle Leases by State
Sales tax paid upfront on total of lease payments: Illinois, New Jersey, New York, Ohio
Sales tax paid upfront on full value of the vehicle: Arkansas, Georgia, Maryland, Minnesota, Oklahoma, Texas, Virginia
No state sales tax: Alaska, Delaware, Montana, New Hampshire, and Oregon
(Some states like Alaska allow municipalities to charge local sales tax.)
How are lease payments typically calculated?
- Determine the Original Value or Capitalized Cost of the car. This usually includes any fees the lessee will pay. (e.g. $22,000)
- Decide on Lease Term in months (e.g. 36 months)
- Determine Rent Charge (e.g. $80/month or 6% APR)
- Lessor determines Residual Value of car at scheduled lease termination (e.g. $10,000)
- Calculate Depreciation = Original Value – Residual Value (e.g. $22,000 – $10,000 = $12,000)
- Monthly Payment = Depreciation / Lease Term + Rent Charge (e.g. $12,000 / 36 months + $80 = $413.33 per month (plus Sales Tax, if any)
How to Lease Out a Vehicle (7 steps)
3. Inspect and Prepare the Vehicle
If the vehicle is used, it should be prepared for lease. In addition to a thorough cleaning, a mechanical inspection should take place. Any issues that represent a safety hazard, and any major mechanical concerns should be repaired or replaced. Cosmetic damage and minor issues that will not be repaired should be well documented for the lessee.
4. List the Vehicle
In order to find potential lessees, the vehicle must be advertised as “for lease.” Some options include parking the vehicle in a safe but well-trafficked area with a sign on it, classified websites, and lease transfer networks like SwapLease and LeaseTrader.
While lease transfer networks are primarily intended for swapping existing dealership leases, the vehicle owner may be able to find a qualified lessee there.
5. Screen Potential Candidates
Potential lessees should be asked to complete a lease application which will include the lessee’s permission to run a credit check. Credit checks can be obtained from either TransUnion, Equifax, or Experian. A credit score ranges from 330 to 830 with a higher score indicating a better credit rating.