By Jennifer McNett, CPA
Manager, Tax Services Group
One of the most frequent questions we encounter as business advisors is whether a client should lease or buy an expensive piece of business property. This can pertain to virtually any kind of asset, from real estate and vehicles to factory equipment and laptop PCs for the staff.
This is a seemingly easy question with a multifaceted answer, as the best course of action is specific to each organization’s circumstances. Depending on your company’s needs – maximizing deductions, preserving cash flow, maintaining newer equipment, etc. – leasing or buying can each lend their own advantages.
In general terms, if cash flow is an issue then leasing is generally the best option. For tax deductions, buying is usually more advantageous, especially when you use accelerated depreciation to expense the full amount up front.
Leasing is more complicated, and you should ask plenty of questions before signing a contract. These include the length of the lease, whether property must be insured, who’s responsible for property taxes, and options for modifying the lease and penalties for early termination.
You should also learn whether the lease is a capital lease or an operating lease. A capital lease is similar to a loan, and the property is considered an asset on the balance sheet, so you obtain the tax benefits of ownership. An operating lease (the more common type) means you rent the equipment or property and the lessor retains ownership. Historically operating leases were expensed and not reported on the company’s balance sheet but new standards beginning in 2020 will require most privately held organizations to record an asset representing the right to use the underlying leased asset over the term of the lease along with a liability for the present value of the lease payments.
Another option is the buyout lease, which can apply to everything from vehicles to computers, in which the lessee agrees to purchase the property at the end of the lease period, sometimes at less than present market value. This is considered a capital lease since you essentially own the equipment at the end of the contract. A buyout lease is generally more expensive than a standard lease, but the company can still take advantage of accelerated depreciation, especially if they are showing profits.
The type of property is also important to consider when choosing between lease or buy. For instance, vehicles are a rapidly depreciating asset in which leases usually include mileage limitations that incur overage fees when exceeded. On the other end, real estate is appreciable instead of depreciable, and control factors can be more important in determining whether you want to be the owner or merely the tenant.
There are many factors to consider when choosing lease or buy, but there are a few general rules of thumb.
The benefits of leasing include:
- Ensuring your equipment is up-to-date.
- Predictable monthly expenses.
- Low cost up front.
Downsides of leasing include:
- You generally pay more in the long run.
- You have to keep paying even if you no longer need the asset.
Benefits of buying include:
- Less complicated than leasing.
- Generally cheaper in the long run.
- Equipment is tax deductible.
Drawbacks of buying include:
- Higher initial cost.
- Getting stuck owning outdated equipment.
If you are unsure whether to lease or buy, seek the advice of a trusted counselor who can look at the practical and fiscal impacts of each and help you weigh which option makes the most sense for your organization.
If you have any question or comments, please call Jennifer McNett in our Tax Services department at (317) 608-6699 or email [email protected].