Does it matter if you own your car or lease your car? Absolutely! You should be taking your company’s equipment purchases just as seriously. Beware of getting muddled in after the fact discussions of tax accounting for leases vs loans, when the magic is in the buying process.
Whether it is a lease or a loan you end up going with, please understand the following before making your purchase:
- Do you get to keep the equipment in the end and if not, what is the process for keeping the equipment or turning it back in? If the seller/lessor tells you that it can be bought at fair market value in the end, how is fair market value determined?
- Is there a balloon payment at the end of the lease/loan?
- Do you own the equipment during the lease period or do they? Are you paying property taxes on it or are they?
- How much is the equipment worth if you bought it outright?
- What is your total cost for leasing or buying the equipment? With loans, that will be interest and fees and with leases, it will include a lease rate and fees. There will also be sales and property tax considerations. It’s impossible to do in your head, so my advice is to ask the lender to give you your total cost figure.
- What are the other fine details regarding wear and tear, events of default, etc.?
- After understanding your true cost, does it feel like a good deal? What is your gut telling you, not only about the deal, but who you are working with?
This is the point, where I’d recommend beginning to look at the special business considerations. With some leases (operating leases, which is more like renting), you can often expense the entire payment to the business, which will reduce your income. With a loan, only interest and depreciation are an expense that reduces income and the equipment becomes an asset. For startups, banks may look more favorably at a higher asset base when you are seeking future loans. Once income tax considerations become an issue, reducing taxable income can be attractive.
Leases and loans come in many shapes and sizes and this is where your accounting and finance partner should be able to look at the lease or loan and do an analysis to help you determine what is best for the company. That part can go pretty fast when you work with someone who is experienced in lease vs. loan analyses and it is definitely worth slowing down before entering into long-term obligations.