What are lease end-of-term, early-termination and buyout options?

An end-of-term option (ETO) is the right of the lessee in a noncancellable finance lease to purchase or continue using a leased asset at the end of the lease term as specified in the lease agreement.  End-of-term options, which are often drafted on separate forms, generally determine the accounting and tax treatment of a lease for both the lessor and the lessee.

The contractual right of a lessee to terminate a lease and surrender – not purchase – the leased asset upon payment of the balance due, including any associated early termination and other costs, possibly with the lessee’s guarantee of the price on the sale to a third party, is an early-termination option (ETO).  An ETO is typically included in a transaction to qualify it as an operating lease.

An early-buyout option (EBO) gives a lessee the contractual right to buy the leased asset for a fixed amount at one or more points in time prior to the final scheduled lease payment.  While an EBO allows the lessee to lock in a known purchase price, it can also reduce the lessor’s end-of-lease residual-value and tax risk if inCommerciald with a fair value purchase option (FVPO).