Owning Versus Leasing Equipment
For many in the construction and real estate industry, machinery and equipment are critical to complete most projects. You know you need equipment on hand or on site, but every business has to ask itself whether to purchase or lease. Both owning and leasing come with advantages, disadvantages and different tax implications. The optimal approach is different for every entity, so it’s important to understand what benefits your business is trying to achieve.
Purchasing equipment could mean accelerated deductions for tax purposes. The current Section 179 election allows up to $25,000 of the cost of an asset—new or used—to be expensed in the year purchased. However, if prior years are any indication, Congress may retroactively increase the Section 179 amount for 2015 to $500,000.
In the past, bonus depreciation was available on new assets, which would allow 50 percent of the cost of an asset to be expensed in the year purchased, with the rest of the cost depreciated over the life of the asset. Bonus depreciation also has been retroactively extended by Congress in the past; we’ll have to wait to see if they do so again for 2015.
Purchasing equipment may require a large down payment or borrowing large sums of money, but you always have the equipment on hand and you can customize the equipment to your specifications. Purchasing is a good option for companies with cash on hand or borrowing capabilities, along with the need for large tax benefits.
According to many companies in the leasing industry, leasing construction equipment is a growing trend. However, accounting for leases can be tricky. There are two types of leases: operating leases and capital leases. The main difference between the two is who’s considered the economic owner of the asset, which leads to different tax benefits. The tax regulations provide specific lease terms to be reviewed to determine if a lease is capital or operating.
Capital leases (also called financing leases) result in the asset being capitalized and depreciated. In this case, the lessee bears the risk of loss if the asset is destroyed and also is responsible for maintenance, taxes and other expenses. For tax purposes, interest expense and depreciation expense will be recognized over the course of the lease, and the lease liability will be recorded on the balance sheet. In addition, Section 179 and/or bonus depreciation would be available in the first year of the lease. Capital leases are a good option for those who need large tax benefits and want to pay off assets over time rather than having a large down payment upfront.
Operating leases result in the rent payments being deducted as rent expense; the lessee is not able to take any depreciation expense. Operating leases tend to minimize monthly cash flow, which reduces deductions for tax purposes. Operating leases are a good option in cases where you do not need additional tax deductions and need to minimize cash flow for using assets necessary to complete a project—or if the asset only will be used for a short, specified time.
It’s important to note that the Financial Accounting Standards Board (FASB) has issued an exposure draft that will affect accounting for leases in financial statements based on generally accepted accounting principles in the U.S. Currently, FASB anticipates issuing a final lease accounting standard by the end of 2015. It’s unclear what impact this could have on the tax accounting for leases.
For more information about owning or leasing equipment or advice on what would benefit your company, contact your BKD advisor.