What Is a Lease Extension?

A lease extension is a contractual agreement between a lessee and a lessor that results in a rental agreement that is extended past its original expiration date. Operating leases are rental agreements in which a piece of property is rented for a certain portion of its useful life while capital leases are rental agreements which usually result in the lessee taking ownership of the leased property. In many instances, a lease extension can be worked out between the parties involved in either an operating or a capital agreement.

Standard operating lease agreements expire after a pre-determined number of weeks, months or years. At this time, the lessee returns the property to the lessor. Some operating agreements include provisions that enable the property owner to assess penalty fees if the lessee has subjected the rented property to unusual levels of wear and tear. To avoid paying these fees, a lessee may attempt to broker a lease extension. Thereafter, the lessee may use the property sparingly so that when the extension expires the property's condition is in line with its age with the result that the lessor cannot assess any penalty charges based on wear and tear.

Capital lease agreements are normally defined as agreements that last for more than 75% of the rented property's useful life. Typically, the renter has the option of buying the rented property for a nominal sum at the end of the lease term. In other instances, the lessee may have the option of buying the property for a pre-set price at any point during the lease term. A lessee may become heavily reliant upon the rented property during the lease term, but may lack the cash to purchase the property at the pre-set price. By agreeing a lease extension, the renter can continue to use the property without having to make a one-time lump sum payment to take ownership of the property.

Like lease agreements, lease extensions, are subject to negotiation. Some contracts include a provision for an extension in which case the rental payments for the extended term may be detailed in the original lease agreement. In many instances, the rental agreement includes an option for the extension but the lessor and lessee have to reach agreement on the terms of the extension when the initial lease term comes to an end. If agreement cannot be reached, the property must be returned to the property owner.

A lease extension may be in the interests of the lessor as well as the lessee because many types of property including vehicles and machinery depreciate over the course of time. In many instances, a lessor may have difficulty renting out an aged piece of machinery or an old car to a new lessee because newer vehicles and pieces of machinery are readily available. In contrast, the current lessee may be more willing than another party to rent the aged equipment because of the cost of replacing it or returning it to the lessee.