New Equipment — Is it Smarter to Lease or to Buy?
Contractors inevitably reach a point when they know they’ll have to retire an old, worn-down piece of equipment and shop around for something new. Deciding on a replacement can be tough. But it’s even tougher trying to decide whether buying or leasing that new piece of equipment makes the most sense. What are the issues you should examine before deciding to lease or buy? Consider these:
Examine Your Cash Position First
Your decision to lease or buy may be based largely on your cash flow. A purchase requires you to either dig into your cash reserves or line of credit for the full price or make a cash down payment and finance the remaining cost.
It’s important to analyze your company’s upcoming cash needs and the financing options available to you before you opt to buy equipment. You’ll want to take into account how financing the purchase could affect your ability to obtain credit for other business needs.
The primary advantage to leasing is that it allows you to budget payments over an extended period. You also can structure the lease payment schedule to suit your normal cash flow patterns. Since leasing frees up cash and credit for other investments, leasing may be a good option if your cash flow is not as good as it should be.
Review Your Tax Situation
Along with cash flow, you’ll also have to consider the tax and accounting implications of buying or leasing equipment.
When you buy equipment, you generally write off the cost as depreciation over time. If eligible, however, you can take advantage of the Internal Revenue Code’s Section 179 “expensing” election. This section of the tax code lets you deduct the cost of qualifying assets in the year your business first places them in service — as opposed to claiming regular depreciation deductions. For 2012, the Section 179 expensing limit is $139,000. This limit will be reduced dollar for dollar as the cost of Section 179-eligible property placed in service in 2012 exceeds $560,000. You cannot expense more than the amount of your taxable income from active trades or businesses.
Moreover, your contracting firm may make an election to write off 50% of the cost of new machinery and equipment placed in service during calendar-year 2012. This 50% first-year depreciation reduces the property’s basis for purposes of figuring regular depreciation deductions.
When you lease equipment, your company may be able to deduct the lease payments as operating expenses. This avoids the alternative minimum tax (AMT) adjustments for depreciation, which can be an important factor if your firm could be subject to the AMT.
However, proposed accounting changes that target leasing may have an impact on the attractiveness of leasing. As things currently stand, there are two categories of leases: capital leases, which have to be reported on balance sheets, and operating leases, which can be structured to stay off the balance sheet.
The Financial Accounting Standards Board (FASB) has proposed standards that would eliminate off-balance-sheet lease financing. The FASB believes that operating leases create an understatement of assets and liabilities and make it difficult to compare financial results for firms that treat leases differently. Essentially, operating leases would be required to be recorded on the lessee’s balance sheet if the proposed changes are adopted. That, in turn, would require significantly more monitoring and recordkeeping and could impact a contractor’s ability to obtain loans or bonding at competitive rates.
Talk to Us
New equipment is a significant expense for most contractors. We can help you run the numbers to determine whether buying or leasing makes the most sense for your construction firm.
“It’s important to analyze your company’s upcoming cash needs and the financing options available to you before you opt to buy equipment.”