Capitalized Cost Reduction

Often called a down payment on a lease, a capitalized cost reduction is to leasing what a down payment is to financing, but there are differences between the two.

When you buy a car, any cash that you put down (and in many states the equity in a trade-in as well), decreases the amount financed before the transaction price is taxed. In other words, you are reducing the selling price and the taxes on the vehicle. The down payment also reduces the overall interest charges on the loan since the loan amount is less.

When you lease a vehicle, the monthly payment is based on the difference between the capitalized cost and the residual value, plus the finance charges. All three of these values are set at the beginning of a lease. When you pay a cap cost reduction to lower the monthly lease price, all you are doing is pre-paying a portion of the lease costs that includes the pre-calculated finance charges. In addition the capitalized cost reduction amount is taxable in those states that tax leases.

For example, if your state has a lease tax of 6%, in order to reduce the capitalized cost by $1,000, you would have to pay the $60 in taxes (6% of $1,000) for the entire $1,000 to be applied to the cap cost reduction (for a total of $1,060).

Like vehicle financing, a down payment on a lease reduces the monthly payment. But unlike vehicle financing, a down payment on a lease will not save you any money.