The cost of capital is rising, and financing is getting harder to secure. As a result, businesses are starting to get creative with financing options and utilizing alternative sources and products, such as terminal rental clause agreement leases or TRAC leases.
Many alternative lending options, such as BNPL, capital lease financing, equipment financing, and the like, bypass traditional banking routes. However, such choices can be hard to understand as they are riddled with dense legalese and industry terminology that requires its own set of research. Below we delve into what is a TRAC Lease, how do TRAC Leases Work, and the various types of TRAC leases. We also explain the benefits of these leases so the business can confidently decide about them.
What is a TRAC Lease?
A TRAC lease, also known as a terminal rental clause agreement lease, is a lease for a motor vehicle, usually a trailer, that allows the lessee to change the terms of the payment, the length of the agreement, and the residuals of the lease, while it is still active. TRAC leases are for those vehicles that businesses will use for commercial purposes for at least 50% of the time.
How do TRAC Leases Work?
Before we look at how TRAC leases work, we will examine how standard leases are structured. Typical motor vehicle leases are in which a certain percentage of the vehicle cost, plus the interest cost is divided into an equal number of payments over the lease term. What remains, in the end, is the residual, the remaining percentage of the cost of the vehicle not included in the lease.
Businesses mostly enter leases with large residuals for vehicles they intend to rent. Alternatively, leases with small residuals are meant for vehicles they intend to purchase.
TRAC leases are more flexible in that the lessor allows the lessee to negotiate the monthly installments and the residual. Effectively, the lessee can decide if they want lower residual or lower installment payments. The monthly installment payments in a TRAC lease are referred to as reserve for depreciation.
After a certain lock-in period with the original lease terms, the lease can continue as is, or the lessee can choose to end it. If the lessee decides to continue the lease after the lock-in period expires, they have the option to make changes to the monthly payments and residuals.
If the lessee decides to end the lease, the lessor will sell the leased vehicle. The amount for which the vehicle is sold is offset against the remaining balance after backing out the reserve for depreciation and depreciation costs. At this point, the lessee may either be due a refund or owe money to the lessor.
Benefits of TRAC Leases
Below are some benefits of TRAC leases that may make such leases a viable option for businesses.
Minimal initial outlays of cash – Loans can require a down payment ranging from 5% to 20%. Therefore, TRAC leases allow small businesses an entry point into owning a significant asset that may have otherwise been out of reach.
Fully tax-deductible payments – TRAC leases are very similar to operating leases in which the vehicle’s title remains with the lessor, designating them as the owner. The lessor benefits from depreciating the vehicle, but the lessee is treated as a vehicle renter; thus, those payments become fully tax-deductible monthly rent payments.
Lower monthly payments – the lessor’s depreciation benefits are also passed through to the lessee in the form of lower monthly installments at a predetermined rate decided on at the start of the lease.
Sales Taxes applicable on payment amount – When a business makes an outright purchase of a vehicle, whether paid in cash or via a loan, the company must pay the total sales taxes due at the time of the vehicle’s registration. However, the sales tax amount is spread over the lease term for TRAC leases, further reducing initial outlays to procure a commercial vehicle.
Types of TRAC Leases
As discussed earlier, TRAC leases are different from traditional leases. They can be amended mid-cycle after a certain lock-in period and don’t abide by conventional lease structure dependent on the initial intentions of the business. Below are some different types of TRAC Leases.
Split TRAC leases – Like a basic TRAC lease, additional protections are added to the lessee’s arrangement. Suppose the lessee decides to terminate the lease after the initial lock-in period. In that case, the lessee’s liability in the event of a shortfall from the sale proceeds is capped at an agreed-upon rate.
Modified TRAC leases – TRAC leases are now considered capital leases based on the US Generally Accepted Accounting Principles. Thus their payments and the vehicle overall are treated as an asset. But a modified TRAC is treated as an operating lease, and its payments are tax-deductible.
Zero TRAC leases – This type of TRAC lease is like a standard lease with a low residual when the lessee intends to purchase the vehicle at the end of the lease. In a zero TRAC lease, the reserve for depreciation is that the residual at the end amounts to zero.
More and more discussion of the changing economic landscape has made borrowing for both businesses and individuals harder to secure and more expensive.
This has raised the prospect of alternative lenders looking to increase their rate of return and have started to offer lending not available through traditional lenders, such as banks.
One such alternative source of financing is the terminal rental clause agreement leases, aka TRAC leases. Businesses have the difficult task of understanding the many other competing lending options available and having to do so by navigating all the industry jargon and the dense legal language. It is essential to reach out to resources that simplify terms and help understand what a TRAC Lease is, how they work, and their various types. It’s also better to understand their benefits to make an informed decision about the product.