Leases and Taxes

Strategically using leases can have a major impact on your business growth and profitability. Your accountant can help you understand how leases can impact your business, and it’s a good idea to include them in these discussions. Leasing equipment versus real estate has different costs and benefits, but you need a solid strategy for maximizing the positive impact on your business for either type.

Leases are typically easier to obtain and have more flexible terms than loans, so they can provide a significant advantage, especially if you have bad credit or need a longer payment plan to lower your costs. Leasing equipment can make it possible to obtain or upgrade expensive equipment and eliminate the cost of obsolescence, but leases are not right for every business. Tax treatment of a lease can vary as well, and this is an important factor in determining when leasing is a good option for your business.

Equipment leases are a good way to demonstrate the differences in tax treatment, so I’ll use these as an example here. A Tax Planner and Business Advisor is a good person to include in all decisions to lease or buy.

Equipment leases can provide flexibility and protection against wear and tear for equipment that is specialized, very expensive, or that needs frequent replacement. There are two different types of equipment leases: operating and finance (or capital) leases. These have different terms and conditions, and are treated very differently in your accounting and tax filings.

At the end of a finance lease, your company owns the leased equipment. Under certain circumstances, this type of lease is better for a business than taking an equipment loan. The equipment you obtain with a finance lease is recorded as an asset on your balance sheet. That means it can be depreciated. A capital lease is also recorded and deductible as an operating expense for the full term of the lease. There are other factors that may make this type of lease a bad choice for your business.

Operating leases are intended for equipment that you will use but plan to return to the lessor. An operating lease is recorded as an operating expense, but there is no claimable depreciation. The leased equipment is not shown on your balance sheet as an asset. The tax benefit of an operating lease is limited to claiming the lease payments as an operating expense.

Companies can offset operating expenses dollar for dollar against income earned. The amount of depreciation that can be expensed is based on the IRS’s determination of what the normal-use lifespan of the item should be, but there is no depreciation deduction for operating leases. The analysis of the benefits of leasing versus purchasing is a bit more complex than this, but this shows how a Tax Planner can help you decide when to lease or take a loan.

This is just some general information and guidance. Helping business owners succeed is the main reason I founded Hundley Advisors. We’re always available for a more in-depth conversation. A good Tax Planner/Business Advisor should be involved in every decision that may impact the financial health and profitability of your business.