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Comparison chart Capital Lease versus Operating Lease comparison chart Capital Lease Operating Lease Lease criteria - Ownership Ownership of the asset might be transferred to the lessee at the end of the lease term. Ownership is retained by the lessor during and after the lease term. Lease criteria - Bargain Purchase Option The lease contains a bargain purchase option to buy the equipment at less than fair market value. The lease cannot contain a bargain purchase option. Lease criteria - Term The lease term equals or exceeds 75% of the asset's estimated useful life The lease term is less than 75 percent of the estimated economic life of the equipment Lease criteria - Present Value The present value of the lease payments equals or exceeds 90% of the total original cost of the equipment. The present value of lease payments is less than 90 percent of the equipment's fair market value Risks and Benefits Transferred to lessee. Lessee pays maintenance, insurance and taxes Right to use only. Risk and benefits remain with lessor. Lessee pays maintenance costs Accounting Lease is considered as asset (leased asset) and liability (lease payments). Payments are shown in Balance sheet No risk of ownership. Payments are considered as operating expenses and shown in Profit and Loss statement Tax Lessee is considered to be the owner of the equipment and therefore claims depreciation expense and interest expense Lessee is considered to be renting the equipment and therefore the lease payment is considered to be a rental expens

Given the circumstances as you describe them, I don't see "doing nothing" as a realistic option. Clearly this was an operating lease. You are fortunate with the timing since all years can be amended. Option # 1 - Amend all years Option # 2 - File a 3115 - Change in Accounting Method In both scenarios you would reverse the previous entries and expense the operating lease payments, then allocate the 70 K residual payment to the assets and capitalize or expense accordingly. The choice between option # 1 or option # 2 would depend on the effect of each years taxes and on whether the 3115 calculations would result in additional tax due or not. If the 3115 resulted in additional taxes then you would get a 4 year spread on the payment. It will be very interesting to see how this turns out. Keep us up to date !