In times when cash is short and equipment needs are piling up, many cities may turn to leases or lease purchase agreements to satisfy the pent up needs. Besides the additional cost of paying over a longer period of time and the interest expense that may be experienced with leases or lease purchase agreements, there are some legal and accounting requirements that must be followed.
In Iowa, lease or lease-purchase contracts for real or personal property are governed by Code of Iowa Section 364.4(4). Cities are only allowed to lease or lease-purchase property for its useful or economic life as determined by the city council. This expected life should be set at a reasonable amount, avoiding any temptation to extend the payment schedule too far into the future. Other features of the agreement may be similar to a private agreement such as the city’s responsibility to pay all costs associated with the use and maintenance of the equipment or property and the payment of principal and interest payments during the agreement.
If the city plans to use property taxes from a debt service levy to repay the principal and interest on the lease or lease-purchase agreement, then the public hearings and resolutions authorizing such action must be done in the same manner as any other General Obligation bond commitment. Be sure to work closely with the city’s bond attorney early in the process. If the city plans to pay for the agreement within the general fund, other stipulations exist:
- The new agreement cannot cause the total number of lease purchase agreements in force to exceed 10 percent of the last certified general fund budget amount for this year or any year during the maturity of the agreements.
- For cities of a population of less than 5,000, the agreement cannot exceed $400,000. For cities of a population of 5,000 but not more than 75,000, the agreement cannot exceed $700,000. For cities with a population of more than 75,000, the agreement cannot exceed $1,000,000.
- If the principal amount of the lease or lease-purchase agreement paid from the general fund exceeds these amounts, then the city must publish a notice 10 days in advance for a meeting to discuss entering into the agreement, including a statement of the principal, the purpose and terms of the lease and the right for a petition to call for an election. Then, 30 days after the meeting the council may take action to enter into the lease unless a petition is filed with the clerk calling for an election.
The city may also authorize a lease or lease-purchase agreement to be repaid with city utility or enterprise funds. The procedures should again be coordinated and overseen by the city’s attorney or bond attorney to make sure Code Section 384.83 is followed with proper notice, hearings and resolution execution.
Property that is leased or lease purchased by a city for public purpose and not used to generate profit (except for electric utilities) is tax exempt for property tax purposes. Structures that are constructed by a private party or by the city for the use by the government have additional restrictions under Section 26.2.3 and should be done under the supervision of the city attorney. Taxation issues for both the city and the private party are subject to strict adherence and procedures set out by the Code of Iowa and Internal Revenue Service regulations. A lease is classified as capital if any one of the following four tests is met:
- The lease conveys ownership to the lessee at the end of the lease term.
- The lessee has an option to purchase the asset at a bargain price at the end of the lease term.
- The term of the lease is 75 percent or more of the economic life of the asset.
- The present value of the rents, using the lessee’s incremental borrowing rate, is 90 percent or more of the fair market value of the asset.
Whether capital or operating, the future minimum payments for the lease must be disclosed as a footnote to the primary financial reports. This commitment is broken out by year for the first five years, and then all remaining payments are combined.
For accounting purposes, the city must consider that long term leases and debt service leases go against the city’s debt ceiling. If the general fund lease has an annual appropriation clause, which means that the lease can be terminated if the council does not authorize an appropriation or payment in any given year, then it would be not be included in the debt ceiling calculation.