Tax Benefits of Leasing - Heartland Financial Group

3 Important Tax Benefits of Leasing Equipment (And What They Mean for Your Business)

To buy or to lease? That’s the question. When acquiring new equipment, it’s important to weigh your options carefully and decide what’s best for the business – but in most cases, the answer is far from straightforward.

In addition to weighty pros and cons, ranging from a heftier upfront deposit to a bigger long-term bill for the equipment, there are also important tax considerations that need to play a role in your decision making – especially after the Tax Cuts and Jobs Act of 2017, which also affects business tax decisions, deductions, and leases.

The tax benefits of Leasing equipment can carry some significant advantages – on the other hand, it isn’t always the ideal solution and may not be the right thing for your business.

The Tax Costs of a Single Purchase

When you buy equipment, you either make an outright cash purchase or finance your equipment with a percentage deposit and periodic payments over the course of an equipment loan’s term.

This takes a considerable amount of free-flowing cash out of your business, cash that has already been earned and taxed. Buying equipment with your post-tax dollars means requiring a much greater pre-tax income to finance the purchase.

When you lease, however, every lease payment counts as a business expense, deducted from your income before taxes.  

Leasing and Section 179 of the IRC

Under Section 179 of the Internal Revenue Code, as amended by the Tax Cuts and Jobs Act of 2017, businesses can deduct the cost of certain property up to a set limit within the first year that the property is placed in service.

This allows businesses to deduct the expenses of leasing equipment in the first year of their lease term, up to a current limit of $1,080,000.

More Money in the Bank

While unconventional, an important benefit to leasing over making an outright purchase or financing equipment over a shorter period of time is that you have better cash flow and more capital to work with.

It’s important for a business to remain flexible and liquid to a certain degree – if every dime your business turns around gets tied up in your assets, you won’t have the means to wind your way out of a sticky situation, whether that’s covering for losses your insurance won’t handle, to paying back taxes for your business in the event of an unexpected tax situation or tardy return.

Being liquid enough to deal with medium-to-worst case scenarios is crucial when running a business. Equipment leasing allows you to remain flexible in the face of financial adversity and still benefit from the revenue brought in by your brand-new equipment – even if it ends up being more costly in the long term.

Why Lease Equipment to Begin With? 

The idea of a lease is to sell the use of something without selling the ownership of it. The common analogy is the cow and the milk – if milk is so cheap, why own a cow?

An equipment lease allows you to make smaller periodical payments to make use of certain equipment for the time you need it, versus making a costly upfront payment and multiple lump-sum payments before you finally acquire ownership or buy it outright.

In a lease, the lessor (owner) still retains ownership over the equipment, but the lessee (user) has the benefit of using it. To make up for the lack of ownership, the lessee doesn’t need to pay as much upfront as they would when trying to finance or outright purchase the same thing for themselves.

Many leases provide a lease option, meaning they provide a provision giving the lessee the option to buy the equipment once the terms of the lease have ended (the lease option), or in cases where the term already covers the full value, pay an arbitrary amount ($1 buyout leases).

The main benefit of a lease is that it does not cost as much in monthly payments to utilize a piece of machinery versus making a greater monthly payment to own the same machine. The downside is that you will not own it unless your lease has an option to purchase it.

There are times when leasing equipment pays for itself – especially if the value of the equipment depreciates considerably for your business, i.e. you need to make regular upgrades for that type of equipment anyway.

In other cases, as with equipment your business might use for 25 years or more, it pays to make larger payments to own the equipment in five to ten years versus continuing to make monthly payments for over two decades.  

It’s Not Always Ideal

Even with the tax benefits of leasing and short-term reduction in costs kept in mind, you will have to weigh your options and consider whether you are better off with access to better cash flow at the cost of a long-term lease or if your business is better served with a different arrangement.

A lease grants access to better cash flow, more capital for other investments, certain tax benefits, the ability to avoid equipment obsolescence, and greater flexibility. On the other hand, a lease may be more costly in the long-term, does not increase the net equity of the business, and may impact the valuation of your business (as investors classify a long-term lease as debt and lease obligations as a liability).

Talk To a Tax Professional 

Ultimately, no matter what you decide, one thing is for certain – tax considerations are crucial. Do the tax benefits of leasing outweigh the negatives? Is it better to buy used or seek financing for new equipment? Will the equipment pay for itself and remain useful and up to date throughout the lease’s term?

Whether to buy or lease is an important decision when acquiring new equipment, and it’s why you should always consult your tax professional first.

The tax benefits of leasing can be great by many factors play a role in making the right choice, including the state of the market for the equipment you’re purchasing, the cost caliber of the equipment, your business’ current liquidity, local and federal tax laws, and recent/upcoming changes in tax legislation, the equipment’s longevity, your business credit score, and much, much more. Talk it over with your certified accountant or a tax pro, or contact us here, and weigh your options carefully.