Are you a business owner looking to acquire new equipment for your operations? Have you considered leasing the equipment instead of purchasing it outright? Equipment leasing can provide numerous tax benefits for businesses of all sizes, making it a wise financial decision for many companies.
In this article, we’ll explore the tax advantages of equipment leasing and why it’s a popular choice for businesses.
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A Quick Definition
Before we dive into the tax benefits of equipment leasing, let’s define equipment leasing. Equipment leasing is a financing option where a business leases equipment from a leasing company instead of purchasing it outright.
The leasing company retains ownership of the equipment, and the lessee pays a monthly lease payment for a set period. Once the lease term ends, they can return the equipment or purchase it outright.
There are different types of equipment leases available. Capital leases (or finance leases) and operating leases (or true leases) are the primary types available.
Capital leases allow businesses to use the equipment for a set time and, at the end of the lease term, have the option to purchase the equipment for a predetermined price. Capital leases can be a good option for businesses that need to use the equipment for a very long period and want to own it eventually.
Operating leases also allow businesses to use the equipment for a set period of time. However, the lessee will generally return the equipment to the lessor at the end of the lease term. Some operating lease agreements offer end-of-lease options, including renewing the lease or purchasing the equipment from the lessor for fair market value (FMV).
Operating leases can be a good option for businesses that need to use the equipment for a shorter period or are unsure of their long-term needs.
Tax Benefits of Equipment Leasing
The benefits of equipment leasing can change depending on the equipment lease agreement you enter. In general, there are several tax advantages of equipment leasing, which we’ll go over now. Afterward, we’ll discuss how the benefits can change based on the type of equipment lease.
Section 179 Deduction
Under Section 179 of the IRS tax code, small businesses can potentially deduct the total price of qualifying equipment financed/leased (or purchased) during a given tax year and receive a significant tax deduction for investing in equipment. However, it’s important to note that this tax deduction has some limitations.
For instance, through 2023, the Section 179 tax deduction is limited to $1,160,000. Businesses can only deduct up to this amount for qualifying equipment purchases made during the year.
It’s also important to note that not all financing (or equipment purchases) qualify for the Section 179 tax deduction. The equipment must be used for business purposes and meet specific requirements set forth by the IRS.
Lower Taxable Income
Leasing equipment is a convenient and cost-effective way to acquire the necessary equipment a company needs and can potentially lower its taxable income.
One significant advantage of leasing equipment is that the lease payments can typically be deducted as a business expense each year rather than depreciating the equipment over several years.
This means companies can immediately deduct the lease payments from their taxable income, reducing their overall tax burden, which is especially beneficial for businesses looking to conserve cash flow—leasing allows for lower monthly payments and preserves working capital.
Additionally, equipment leasing can provide businesses more flexibility and ease of use. As technology and equipment needs evolve, companies can more easily upgrade their equipment by leasing, staying current with industry trends, and remaining competitive. Doing so can help support increased productivity, efficiency, and profitability.
No Depreciation Recapture
When a business purchases equipment and then sells or disposes of the equipment, it may have to recapture any depreciation taken on the item, known as depreciation recapture, a tax provision that requires businesses to repay any tax deductions claimed for depreciation when they sell or dispose of an asset.
This can be a costly and unexpected expense, potentially affecting profits and negatively impacting cash flow.
Fortunately, equipment leasing can provide a solution to this problem. When a lessee leases equipment, the leasing company generally retains ownership of it, and the lessee pays for its use.
When the lease term ends and the equipment is returned to the leasing company, the lessee does not have to worry about depreciation recapture, as they did not own the equipment. This can provide significant peace of mind for businesses by helping them avoid unexpected and potentially costly expenses down the line.
Sales Tax Savings
When a business purchases equipment, they are typically required to pay sales tax on the full purchase price upfront, which can be a considerable financial burden. However, when a business leases equipment, the sales tax is spread out over the lease payments, resulting in significant savings for businesses, especially when leasing expensive equipment.
Leasing equipment can help businesses free up cash flow and maximize their financial resources. By leasing instead of purchasing equipment outright, companies can make smaller, more manageable payments over time, keeping more money in their pockets.
No Obsolescence Risk
Equipment leasing provides businesses with the latest and most advanced equipment and eliminates the risk of obsolescence. With technology evolving rapidly, it can be challenging for companies to keep up with the latest equipment trends and advancements.
But equipment leasing allows businesses to upgrade to newer and more advanced equipment at the end of the lease term without worrying about being stuck with outdated equipment, helping them stay ahead of the curve and maintain a competitive edge in their industries.
Leasing equipment can allow businesses to try new equipment and technologies without committing to a significant upfront investment. By leasing equipment, companies can experiment with new technologies, test out new products, and evaluate their performance before committing to a purchase.
Can Tax Advantages Change Based on Equipment Lease Type?
The tax benefits of equipment leasing can be a major advantage for businesses, but do they change depending on the type of equipment lease?
In general, the tax benefits of equipment leasing are available for all equipment leases. This includes finance leases, operating leases, and sale-leasebacks. Businesses can still take advantage of tax benefits such as depreciation and interest expense deductions, regardless of the type of lease they choose.
However, it’s important to note that the tax benefits of equipment leasing can vary depending on the specific terms of the lease and lease type, leading to the use of different accounting methods that can significantly impact the taxes owed by a business.
For example, if a lease term is shorter than the equipment’s useful life, the company may not be able to take advantage of full depreciation deductions. Similarly, if a lease has a purchase option at the end of the lease term, the tax benefits may differ from a lease without a purchase option.
Ultimately, the tax benefits of equipment leasing should be considered on a case-by-case basis, taking into account the specific terms of the lease and the individual needs and goals of the business.
By working with a knowledgeable equipment leasing provider and consulting with a tax professional, businesses can ensure that they take full advantage of available tax benefits and make the most financially sound decision for their company.
A Closer Look at Tax Advantages: Operating Lease vs. Capital Lease Tax Benefits
We’ve gone over the fact that equipment leasing can provide different tax benefits to business owners depending on the type of lease agreement. But let’s take it a little further and compare the differences between operating leases and capital leases. Both options have their advantages and disadvantages.
One of the primary benefits of a capital lease is that it allows companies to own the equipment at the end of the lease term. By the end of the lease term, the business will have paid off the equipment's entire cost, and the asset will be fully owned.
With an operating lease, the equipment is often returned at the end of the lease term (some leases provide end-of-lease options that include the ability to purchase the equipment), and the business is not responsible for any residual value. This can give companies more flexibility and provide a way to stay up-to-date with the latest equipment without worrying about obsolescence.
Another key benefit of a capital lease is that it allows businesses to take advantage of tax benefits, such as depreciation and interest expense deductions. Since leased equipment is considered an asset on the balance sheet, companies can depreciate it over time and take advantage of tax savings.
On the other hand, an operating lease is considered an operating expense and cannot be depreciated. However, the lease payments are considered tax-deductible since they are treated as an operating expense, reducing a company’s overall tax liability for the tax year.
The decision to choose a capital lease or an operating lease depends on each business's individual needs and goals. By considering factors such as equipment usage, long-term needs, and tax benefits, companies can make an informed decision that best suits their financial needs and goals.
In Conclusion
Equipment leasing can provide numerous tax benefits, create opportunities for significant savings, and eliminate the risk of obsolescence. From the Section 179 deduction to lower taxable income, there are several ways companies can reduce their tax liabilities each tax year by leasing the equipment they need.
By understanding the advantages of equipment leasing, business owners can make an informed decision that best suits their financial needs and goals when acquiring new equipment for their operations. Interested in leasing?Learn more about our leasing program.
Some Leasing FAQs
- Is equipment leasing a better financial option than purchasing equipment outright?
It depends on the specific needs and financial situation of the business. Equipment leasing can provide tax benefits, eliminate the risk of obsolescence, and improve cash runway, but purchasing equipment outright may be more cost-effective in the long run.
- Can businesses deduct lease payments as a business expense on their tax returns?
Yes, businesses can deduct lease payments as a business expense on their tax returns. With Excedr’s operating leases, payments are potentially 100% deductible.
- Are there any disadvantages to equipment leasing?
One potential disadvantage of equipment leasing is that the total cost over the lease term may be higher than the cost of purchasing the equipment outright.
- How long is the typical equipment lease term?
Equipment lease terms can vary but typically range from 12 to 60 months. With Excedr, our leases range from 24 to 60 months.
- Can businesses purchase the leased equipment at the end of the lease term?
Yes, businesses can purchase the leased equipment at the end of the lease term if they wish to keep it. The purchase price will depend on the lease agreement and type of lease, but generally, it is typically the fair market value of the equipment at the time of purchase.
