What To Know About Leasing Our Machines.
Two general types of lease plans are available. The major factor that distinguishes these plans is by how they are treated for tax purposes.
An operating (or true) lease calls for a series of regular payments, usually annual or semi-annual, for a period of years. At the end of the lease period, you have the option of purchasing the machine at a price approximately equal to its fair market value. The option price may be set when the lease is signed or it may depend on the accumulated use and condition of the machine when the lease expires.
Alternatively, the machine can be returned to the dealer or lease company, or the lease can be extended. The lease payments are reported as ordinary expenses on your tax return. If the purchase option is exercised, the machine is placed on your depreciation schedule with a beginning basis equal to the used purchase price.
A finance lease is treated as a conditional sales contract by the IRS. You are considered to be the owner of the machine so it is placed on your depreciation schedule. Payments made to the lease company must be divided into interest and principal, with the interest being tax deductible. Many finance leases are essentially installment loans with balloon payments after three to five years. The difference is that at the end of the lease period, you have the choice to either return the machine to the dealer (and give up ownership), or make the balloon payment (and take ownership). Since the finance lease is not taxed as a true lease, the final buy-out price (balloon payment) can be quite variable, depending on the length of the lease and the size of the payments.
Advantages of leasing
Although leasing may not be for everyone, there are several advantages.
- Lower payments, compared to most conventional loans. One reason the payments are lower is that you are building little or no equity in the machine. At the end of the lease period you have nothing except the right to exercise the purchase option.
- Machinery leasing utilizes operating capital instead of investment capital. Payment schedules can be matched to periods of high cash flow.
- Cash requirements for machinery are constant and known in advance. This is particularly beneficial for high volume, low equity operators who can’t afford large capital outlays at a point in time.
- If you routinely trade major machinery items every few years, you will find that leasing generally offers lower payments than the payments on a loan used to purchase the machine.
- If you are near retirement, you may prefer to lease equipment so that it can be easily liquidated in a few years with no income tax recapture.
- Leasing also offers you the chance to try out a particular machine for a few years without buying it.
Leasing is not for everyone
Lease companies are in business to earn a return on their capital. If you have enough money to purchase machinery outright, you will usually spend less in the long run by owning it. This is especially true for machinery that will be owned for five to ten years or more. In addition, you build equity through ownership.
Expense method depreciation
In addition to regular depreciation, you may be eligible for expense method depreciation during the first year. This deduction is available for machinery purchased or leased under a finance lease, but not under an operating lease. So, you may prefer to acquire the machinery by an outright purchase or a financial lease and take full advantage of the early depreciation option. However, if you buy other property that can also utilize the expense method depreciation, you may have already reached your limit for the year.
Ready to find out more about Leasing?
You can apply for our flexible leasing options right online.