Often, the most difficult fact to determine in a lease agreement is the fair value of the leased property. Sometimes, the lessor does not want you to know; other times, particularly when leasing part of a building, there may be no directly comparable sales price available. In general, the definition is “the price for which the property could be sold in an arm’s-length transaction between unrelated parties. The following are examples of the determination of fair value:
(a) When the lessor is a manufacturer or dealer, the fair value of the property at the inception of the lease will ordinarily be its normal selling price, reflecting any volume or trade discounts that may be applicable. However, the determination of fair value shall be made in light of market conditions prevailing at the time, which may indicate that the fair value of the property is less than the normal selling price and, in some instances, less than the cost of the property.
(b) When the lessor is not a manufacturer or dealer, the fair value of the property at the inception of the lease will ordinarily be its cost, reflecting any volume or trade discounts that may be applicable; However, when there has been a significant lapse of time between the acquisition of the property by the Lessor and the inception of the lease, the determination of fair value shall be made in light of market conditions prevailing at the inception of the lease, which may indicate that the fair value of the property is greater or less than its cost or carrying amount, if different.
For most equipment leases, it is reasonably simple to get an equivalent purchase price. Real estate leases are often more difficult. If your company has a real estate department, it may be able to give you comparable purchase prices based on the square footage and type of property (including type of building) you are leasing; if your company does not have a real estate department, your real estate broker may be able to assist you.
In some circumstances, it may not be possible to determine a fair market value; a common example is a lease for a part of a building. “If the fair value of the leased property is not objectively determinable, the lessee shall classify the lease according to the criterion of paragraph 7(c) only [the economic life test], using the estimated economic life of the building in which the leased premises are located.” [¶28a(ii)] The 7(d) present value test is skipped. (The 7(a) and 7(b) tests, of course, always apply, but are unlikely to be relevant when leasing part of a building.) In EZLease, you should check the Fair Value Not Determinable field in this situation. However, it is always best to try to determine a value if possible.