A Bargain Purchase Option (BPO) is a provision in an equipment lease that grants the lessee the right to purchase the leased asset at the end of the lease term for a price significantly below its expected fair market value — typically a nominal amount like $1 or 10% of original cost — which economically transfers ownership to the lessee and triggers finance lease (vs. operating lease) classification under FASB ASC 842 (https://www.fasb.org/standards/accounting-standards-updates). The IRS likewise treats BPO leases as conditional sales rather than true leases, allowing the lessee to claim depreciation deductions under 26 U.S.C. § 168 (https://www.irs.gov/publications/p946).
The BPO test is one of the five criteria under FASB ASC 842-10-25-2 for determining whether a lease should be classified as a finance lease (formerly 'capital lease' under ASC 840) by the lessee. If a lessee is reasonably certain to exercise a purchase option at a price significantly below expected fair market value — a 'bargain' — then the economics of the arrangement are equivalent to ownership, and the lease must be treated as a financed purchase on the balance sheet. Finance lease accounting consequences: When a lease is classified as a finance lease due to a BPO (or any other criterion), the lessee must: (1) recognize a right-of-use (ROU) asset equal to the present value of all lease payments plus the exercise price of the BPO, and (2) recognize a corresponding lease liability. The ROU asset is then depreciated (not amortized as in operating lease) over the useful life of the asset — not just the lease term — because the BPO effectively transfers ownership. Interest on the lease liability is recognized separately, creating a front-loaded expense pattern. IRS treatment: The IRS looks through form to substance. A lease with a $1 purchase option at end of a 5-year term on equipment with a 10-year useful life is a conditional sale, not a true lease. The 'lessee' is actually the owner for tax purposes and can claim MACRS depreciation (and potentially Section 179 or bonus depreciation) on the equipment from inception. The 'lessor' is treated as having made a loan — recognizing interest income rather than lease income (IRS Rev. Proc. 2001-28, https://www.irs.gov/irb/2001-19_IRB). SBA equipment loan alternative: For small businesses, comparing a BPO lease against an SBA 7(a) equipment loan is a key financing decision. A BPO lease structures the transaction as a lease but with guaranteed end-ownership; an SBA equipment loan purchases the asset directly. SBA 7(a) loans for equipment (up to 10-year terms) often provide competitive all-in cost vs. equipment lessors' implicit rates, plus the asset is owned from day one — important when the asset is the primary collateral. SBA's SOP 50 10 7.1 (https://www.sba.gov/document/sop-50-10-standard-operating-procedure) permits SBA financing of equipment purchases but does not finance BPO lease payments directly.
Under ASC 842, a BPO exists when the lessee has a purchase option and, at the lease commencement date, the lessee is 'reasonably certain' to exercise it because the exercise price is significantly below the expected fair market value of the asset at the option date. A $1 buyout on a $100K machine with 5 remaining useful life years is clearly a BPO. A $50K option on a machine expected to be worth $55K is less clear — the standard requires judgment about 'reasonably certain' exercise, considering economic incentives, lease term relative to asset life, and customization.
Finance leases with BPOs appear as both an asset (ROU asset) and a liability (lease obligation) on the balance sheet under ASC 842. Lenders analyzing a business's financial statements will see the lease liability in the debt schedule — it is treated similarly to a term loan obligation in leverage and DSCR calculations. Businesses that previously kept equipment leases off-balance-sheet under ASC 840 may show higher leverage ratios after ASC 842 adoption, which can affect financial covenant compliance and loan eligibility. Lenders should request a full lease schedule to understand all BPO and non-BPO lease obligations.
It depends on cash flow, tax strategy, and credit availability. A BPO lease preserves upfront cash (lower down payment than a purchase loan), can structure payments to match revenue cycles, and — under IRS treatment as a conditional sale — still allows depreciation and Section 179 deductions. Against this, BPO lease implicit rates are often higher than SBA equipment loan rates, and the lessor retains title until the buyout is exercised, which can complicate subsequent borrowing against the equipment as collateral. For most established small businesses with SBA loan access, a direct equipment purchase with SBA 7(a) or conventional financing is typically more cost-effective.