A TRAC (terminal rental adjustment clause) lease is a tax-oriented lease of qualified motor vehicles and trailers. A TRAC lease permits or requires an adjustment of rentals according to the amount realized by the lessor upon a sale of the leased equipment.
When a company engages in a TRAC lease with a lessor, the two parties agree upon an estimated residual value (sometimes called the “TRAC amount”). The TRAC amount is the dollar value that the lessee must pay at the end of the lease to the lessor in order to fully purchase the equipment. Typically the TRAC amount agreed upon results in an inverse relationship in regards to monthly payments (i.e. the higher your residual, the lower your monthly payments, and vice versa). This structure can be highly beneficial to the lessee, providing a wide variety of options that can enable them to improve and better manage their cash flow. Additionally, some TRAC leases allow for flexibility in term length.
If the lessee decides to terminate the lease after the minimum required term, the lessor has the option to purchase or sell the equipment. Alternatively, the lessee can continue the lease with corresponding adjustments to their monthly payments as well as the estimated residual value of the equipment. However, if the lessee does not want to purchase the equipment for the TRAC amount or make corresponding adjustments, the lessor will attempt to sell the equipment. If the equipment sells for more than the agreed upon TRAC amount, the lessee obtains a rebate of rent equal to some or all of the excess sale proceeds. If the equipment sells for less than the TRAC amount, the lessee must pay additional rent equal to some or all of the deficiency. This also demonstrates another benefit of a TRAC lease in that the lessee is allowed to share in the residual sales value of the equipment.
Similarly, a Split-TRAC Lease follows the same principle as a TRAC Lease except the Lessee’s potential lease-end exposure is limited to a portion of the Estimated Residual Value.