LEASE vs. FINANCE - ADVICE FOR BUSINESS OWNERS & ENTREPRENEURS
by Carmela DeNicola
Lease vs. Finance
The decision to Lease vs. Finance is no easy task because it involves a series of complex calculations that the average business person may not easily understand. While lower payments with a lease may seem extremely attractive, there usually are additional costs involved that may make this option ultimately more costly than a financed purchased. In both instances, the business will be asked to sign a legal and binding agreement. While your first inclination may be to seek the advice and counsel of your attorney, a better alternative may be to seek the advise of professionals who handle Vendor/Contract Management.
Leasing is an option that businesses of all sizes use to gain access to costly assets like, office equipment, machinery, and facilities. When a business leases an asset, they are agreeing to make payments in return for
the use of that asset for a set period of time. There is no transfer of ownership of the asset with leasing; only the right to use the asset.
Leasing agreements can be set up for any period of time that is mutually agreeable to the owner of the asset (the lessor) and the person or company who will be using it (the lessee). While there are no restrictions on the number of years two parties can set for a lease, generally the lease period will never exceed the expected life of the leased asset. The duration of the lease, the cost of the asset, and the frequency of payment are all factors that are considered when the lessor provides the payment amount and schedule.
As with any management decision, there are both pros and cons associated with leasing. One of the advantages of leasing is that it does not require a large down payment which would normally be required with a conventional commercial loan. Another advantage of leasing is that it does not commit a person to owning an asset that could become technologically obsolete as newer and more advanced technology is available in the market place.While leasing has some advantages, it also has some disadvantages. The biggest drawback to leasing is that it does not allow a business to build equity in an asset. Whether the advantages of leasing outweigh the disadvantages depends upon the business circumstances.
Lease payments are deductible expenses for tax purposes. This is an important point because it means every dollar paid as a lease payment reduces the taxable income. This is not the case when an asset is purchased or is financed with a loan. Only depreciation expenses and interest paid on loans are tax deductible expenses. It is recommended that you consult with your tax advisor prior to making any decisions of this nature.
Many lease arrangements give a lessee (the user) the option of purchasing the leased asset at the termination of the lease. In cases where an asset is purchased that was previously leased, the price paid for the asset has to be at or near the fair market value of the asset or else the Internal Revenue Service (IRS) will consider the lease a purchase for tax purposes. This is an important point because if the IRS rules that the lease was actually a purchase arrangement, amended tax returns have to be filed for those years where lease payments were originally claimed as deductions. In order to insure that you do not have to go through the hassle of filing amended tax returns, you should only exercise a purchase option on a leased asset when the purchase price is at the fair market value of the asset. Failure to do so can result in a lot of headaches and paperwork, or at the extreme, a stressful IRS audit.