Should Manufacturers Buy or Lease Equipment?
If your business is in a position to acquire equipment or machinery, management faces a tough decision: Should you lease it, or should you buy it? There’s no universal “right” answer. Here are some factors to consider.
Advantages of Buying
One of the biggest advantages of buying over leasing is the ability to write off the full cost of eligible equipment purchases up front, using 100% bonus depreciation or Section 179 expensing. These write-offs are available whether you finance the purchase or pay cash.
Usually, bonus depreciation is preferable because, unlike Sec. 179, it’s not limited to your net taxable income (which means it can generate or increase an overall tax loss). Sec. 179 also imposes a limit on deductions (currently, $1.05 million) and is phased out once total fixed-asset investments exceed a certain threshold (currently, $2.62 million). Keep in mind, however, that 100% bonus depreciation is available only for assets placed in service through the end of 2022 (with certain exceptions), after which this tax incentive will gradually be reduced and then eliminated after 2026.
Writing off the cost of newly purchased equipment can be a valuable tax break. But sometimes it makes sense to forgo these immediate deductions and recover the cost over time through depreciation (typically over five, seven or 15 years). For example, if you believe that the government will increase tax rates or that you’ll be in a higher tax bracket in future years, depreciation deductions may be worth more down the road than they are today. Also, if your company is structured as a pass-through entity — such as an S corporation, limited liability company or partnership — you and the other owners may be eligible to deduct up to 20% of your qualified business income (QBI) from the company.
The QBI deduction can’t exceed 20% of your adjusted taxable income from the business, however. Taking bonus depreciation or Sec. 179 deductions reduces your taxable income, so it may reduce your QBI deduction as well. (Note: The QBI deduction is scheduled to expire after 2025.)
Advantages of Leasing
Despite the tax breaks associated with buying equipment, leasing also has its advantages. Examples include:
- Lower down payments,
- Lower monthly payments, and
- Less risk of obsolescence.
Outdated equipment can be upgraded at the end of the lease term, but this advantage tends to diminish as the lease term increases. A long-term lease does little to reduce the risk of obsolescence and may even increase your risk, since your obligation to make lease payments continues even if you cease using the equipment. And, of course, for certain long-lived assets, buying allows you to keep the asset indefinitely, while leasing requires you to repeatedly renew a lease or negotiate a new one when it expires.
Review Lease Accounting Rules
Traditionally, another advantage of leasing has been the ability to keep operating leases off the company’s balance sheet. But new lease accounting rules that take effect soon will eliminate this advantage for companies that follow U.S. Generally Accepted Accounting Principles (GAAP). Under the new rules, companies will be required to report the assets and liabilities associated with all leases with terms of a year or longer on their balance sheets. By increasing the amount of debt on a company’s balance sheet, this change can result in technical violations of loan covenants and cause lenders and investors to view the company’s financials less favorably.
After a one-year deferral due to the COVID-19 pandemic, private companies are now required to adopt the new lease accounting rules for fiscal years beginning after December 15, 2021, and interim periods within fiscal years beginning after December 15, 2022.
No One Right Answer
Unfortunately, in the buy vs. lease debate, there isn’t a universal right answer. It depends on your particular circumstances and an analysis of the relative advantages and disadvantages of each option. Contact us and we can help you weigh the pros and cons.