My clients have asked me this question a lot of times over the years For the past few years, I have been answering them with humor by asking “what color is it?”. For the most part, my response is appropriate because the car is already home in my client’s driveway, or they have just signed the ink in the business manager’s office at the car dealer.
As with most things in life, understanding the specific facts and circumstances is necessary to get the correct answer. This year there are added factors – special tax rules expire that seriously impact the answer to this question.
Growing companies need to update or add equipment constantly—particularly with the ever-shorter shelf life of computer systems, software and other technology. And special tax benefits available in 2013 make this a good time to consider springing for gear that could help your business. But that still leaves the question of whether to buy or lease—weighing the demand for up-to-date equipment against the need to balance budgets and keep spending in line. A Good Year to Buy or Lease.
The Tax Write Offs
First, lets discuss the best possible scenario – writing everything off in the year you purchase it. Under Section 179 of the Internal Revenue Code, taxpayers that purchase new or used qualifying business property and place it in service in 2013 can immediately deduct up to $500,000 of its cost (though this amount phases out dollar-for-dollar beginning at $2 million, and phases out completely at $2.5 million).
But wait, there are more goodies! Taxpayers can also take advantage of the temporary additional “50% bonus depreciation” deduction on qualified capital expenditures (new equipment only). 50% bonus depreciation applies in addition to the Section 179 deduction. Alternatively, you may benefit from this temporary 50% bonus depreciation indirectly by entering into a true lease, in which the lessor will efficiently utilize the available tax benefits resulting in lower rents and a reduced cost of financing. But those benefits won’t be available for much longer; bonus depreciation is currently scheduled to sunset in 2014 (for most property) and the annual Section 179 deduction amount is scheduled to drop to $25,000.
Why You Should Buy
If your company is in need of assets with a long shelf life, such as farm equipment or furniture, purchasing them may cost less than leasing over the long term. If cash flow is temporarily tight, you can obtain financing as a loan or line of credit to make a purchase and then pay yourself back when income begins flowing more freely. It’s important however, to understand the risks involved with using LMA.
The Benefits of Leasing
Perhaps the biggest apparent advantage of buying equipment is that when your business finishes paying for it, it’s yours. Yet that pro can turn into a con if the equipment has lost most of its capabilities and/or usefulness. In contrast, leasing can offer protection against obsolescence. You are able to acquire the latest technology for little or nothing initially and then swap it for newer equipment when the lease term is up.
If you don’t have a lot of cash on hand, leasing can be a quick, easy way to acquire equipment. A conventional loan would typically require you to make a 20% down payment—and on, say, a $100,000 purchase, that means coming up with $20,000. A lease normally lets you finance 100% of the value of the equipment, and you can secure the lease with the equipment itself rather than having to pledge other assets as collateral.
Leases can be structured in several different ways, depending on your needs. For example, a lease/purchase allows you to decide at the end of the lease whether to purchase the equipment at a predetermined or fair market price; to continue the lease on a monthly basis; or to return the equipment to the leasing company. As another example, a lease/purchase can help if you know you want to own the equipment but don’t have the cash for a hefty down payment. This option provides 100% financing for the equipment itself, plus 20% financing for “soft” costs, such as taxes, freight and delivery. At the end of the lease term, you have the option to purchase the equipment for fair market value or even as low as $1.
The Bottom Line
To figure out whether to lease or buy, it helps to determine the net cost of ownership—your break-even point, overall expenses, including financing costs, minus any tax benefits. Then you can weigh that amount against your current cash flow needs and other considerations. If you plan to buy the equipment or exercise a purchase option at the end of a lease, the potential resale value also comes into play.
Work with your CPA to calculate what’s appropriate for your situation. And if you’re considering taking advantage of Section 179 deductions and bonus depreciation, make sure to consider all the rather complex rules that apply to those deductions. Not following the law to the letter, or missing important deadlines, could deprive your business of potentially valuable tax advantages.
Consider discussing the following questions with your CPA when weighing your options for buying or leasing business equipment:
- Given my company’s current needs, cash flow and tax situation, would it make sense to acquire business equipment this year?
- How would the 2013 rules on Section 179 deductions and bonus depreciation affect the equation?
- What kinds of leases qualify for this year’s accelerated deductions?
Adopted from Lesya Pelyushko Merill Lynch June 2013 Perspective email newsletter