Recent passing of the Tax Cuts and Job Act has created many new tax rules for small businesses. This includes the decision as to whether to leasing or buying equipment or other fixed assets. There is no actual universal “right” choice between buying or leasing. However, many businesses that formerly leased assets are now deciding to purchase them.
From a cash flow perspective, leasing can be more attractive than buying. Plus, leasing does provide some tax benefits. This includes payments for leases generally being tax deductible as “ordinary and necessary” business expenses. Please note though, that annual deduction limits may apply.
In prior years, there have been many advantages in leasing from a financial reporting standpoint. However, as of the 2020 calendar year the new accounting rules will be bringing leases to the lessee’s balance sheet for private companies. So, lease obligations will soon be showing up as liabilities. This new scenario is similar to purchasing assets and financing them with traditional bank loans.
Leasing over buying equipment also has some potential drawbacks. In the long run, leasing business assets may cost you more than purchasing it. Plus, leasing doesn’t provide any buildup of equity. What’s more, you’re generally locked in for the entire lease term. So, there is an obligation for you to keep making lease payments even if you stop using the equipment. An early-termination fee may also apply if the lease allows you to opt out before the term expires.
Historically, the primary advantage of buying over leasing equipment has been that you’re free to use the assets as you see fit. But an advantage that has now come to the forefront is that Section 179 expensing and first-year bonus depreciation. Both of these tax breaks can provide big tax in the first year after placing an asset in service.
There has been a dramatic enhancement in these two tax breaks by the Tax Cuts and Jobs Act (TCJA). Enough so that it might convince you to buy assets that your business might have been leasing in the past. Many businesses will be able to write-off the full cost of most equipment in the year of its purchase. Any remainder is eligible for regular depreciation deductions over the corresponding IRS schedules.
While you may be considering buying business assets to reduce tax, remember that it generally requires you to pay the full cost upfront or in installments. Although, you can still finance property with the Sec. 179 and bonus depreciation tax benefits. If you finance a purchase through a bank, there is a general requirement for a down payment of at least 20% of the cost. This could tie-up funds and affect your credit rating. If you decide to finance fixed asset purchases, be aware that the TCJA limits interest expense deductions to 30% of adjusted taxable income. This specifically applies for businesses with more than $25 million in average annual gross receipts.
When deciding whether to lease or buy a fixed asset, there are a multitude of factors to consider, including tax implications. We can help you determine the approach that best suits your circumstances.