Should You Buy Or Lease
When your business needs new equipment, you have to decide whether you should lease or buy what you need. Is an operating lease the right move for your company? Or would a capital lease be better?
When businesses need equipment for their operations, they have the choice of buying or leasing what they need. This includes everything from cars to tractors and there are pros and cons to every option.
Buying versus Leasing
When you buy, you are responsible for paying the cost of the item, including any financing charges as well as for maintenance and upkeep. You can sell the equipment at any time, or you can keep it for as long as it remains useful and productive. You also can benefit from any associated tax deductions and credits.
If you decide to lease instead, you (the lessee) pay the lessor for the use of the equipment during the term of the lease. You also may have to pay to insure the equipment (e.g., a company car). The lessor is responsible for most maintenance costs, although you likely will pay for upkeep and any wear and tear that is not considered “usual.” In addition, you usually are responsible for additional costs if you terminate the lease before its maturity date. When the lease ends, you simply return the equipment or buy it at an agreed-on price (usually its then-fair-market value). Alternatively, you can renew the lease.
Businesses often choose to lease equipment rather than buy it either because (1) the upfront costs are lower, freeing up cash; (2) the equipment has a short useful life and will need to be replaced quickly; and (3) lease payments on business equipment often can be used as a deductible business expense, offsetting any finance charges.
Operating and Capital Leases
Leasing is a great option for many businesses, but consider a few basics before you decide to lease:
Operating leases usually are short-term leases (12 months or less) in which the equipment is returned to the lessee at the end of the term. Lease payments are deductible operating expenses, but the equipment never is considered to be an asset for tax purposes.
Capital leases are long-term leases that are recorded on your balance sheet and treated as assets for tax purposes. To be considered a capital lease, the terms of the lease must meet one or more of these criteria:
- The lease term exceeds 75% of the estimated life of the equipment.
- The value of the lease payments is more than 90% of the equipment’s fair market value.
- You automatically get title to the equipment by the end of the lease term.
- The lease has a purchase option for substantially less than the equipment’s fair market value.
Most businesses use both types of leases, depending on the equipment. For example, a construction company that frequently uses a particular type of crane for its clients probably should consider a capital lease. The equipment lasts for a long time and the design doesn’t change much over time. If, however, the company is leasing a car for the project manager to use to get from site to site, an operating lease would be the better option because the design and technology will change over the term of the lease, making the car obsolete.
As always, it is important to look at the tax and other business consequences of your decision before you sign a lease. Contact us if you need help evaluating your lease options.