@Mike9241
@taxquestionasker85
I missed that the owner keeps the vehicle. That adds one extra element.
I also want to clarify the cost basis. As far as I know, with a lease you "buy" a fraction of the car, possibly with finance charges, and there is a set price to buy out the remainder of the car at the end of the lease if you want to keep it. So the customer's basis would be the lease price for the first half (or whatever) fraction of the car, not including finance charges.
Then, because the customer is keeping the vehicle, in addition to any amount over the basis being taxable, the basis is reduced to zero. The basis may be increased by future lease payments (principal only) and the basis may be increased if the customer pays the buyout on the lease rather than returning it. That has implications if the customer keeps the car. Because, if you later sell the car (as a used car) for more than your basis, you have a taxable capital gain. This doesn't usually happen with used cars but it could here.
For example, suppose the price of the car with sales tax was set in the lease documents as $50,000, with the lease being for 2 years at $25,000 plus finance charges. You take the settlement, which reduces your basis to zero, and you have a $15,000 capital gain. At the end of the lease you decide to buy the car for the remaining $25,000. Your adjusted cost basis is now $25,000. Then suppose you sell the car as a used car for $30,000. $5,000 of that sale is a taxable capital gain because the sales proceeds are more than the cost basis after taking all adjustments into account.
Alternatively, suppose this model of car suddenly becomes very popular and the dealership offers to buy you out of the lease early for a $5000 payment. Because your basis is zero after the settlement, the buyout payment would be a taxable capital gain.
As I said, outside of business vehicles with depreciation, owners of personal cars almost never sell them for more than their cost basis, so this sort of thing almost never comes up. But you will need to keep track of your basis.
