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Recent tax changes are shifting the benefits and drawbacks that come from leasing or buying fixed assets such as equipment. No two companies are the same, but it is becoming common for companies to switch from leasing to buying their fixed assets.
Leasing is more attractive than buying for cash flow, and leasing does have some tax benefits. The tax benefits include payments that are generally tax deductible as “ordinary and necessary” business expenses.
It used to be beneficial to lease for financial reporting purposes. Recent changes in accounting rules have changed this going into effect in 2020. Leases are now being reported on the balance sheet as liabilities, similar to purchased assets financed with bank loans.
There are some direct drawbacks from leasing. First, leasing an asset will likely cost more than buying it over time, and leasing doesn’t create a buildup of equity. A lease also includes a contract, locking you in for the term of the lease; this means you make lease payments even if you aren’t using the equipment. Even when leases do allow you to end the lease before the term is up, they often include an early termination fee.
Historically, buying was advantageous in that it allowed freedom to use assets as you see fit. A new advantage is that Section 179 expensing and first-year bonus depreciation provide large tax savings in the first year the asset is in service.
The Tax Cuts and Jobs Act (TCJA) enhanced the tax breaks for Section 179 expensing and first-year bonus depreciation. These enhancements are so significant you may consider buying assets that your company has leased in the past. Many companies will be able to write off the entire cost of the asset the year that it is purchased, and any remainder can be written off under depreciation deductions using the IRS-prescribed rates and schedules.
The main drawback of fixed assets is that they come with the disadvantage of having to pay the full cost of the equipment upfront or in installments.
Financed property is also eligible for Section 179 expensing and bonus depreciation tax benefits. Financing through a bank usually requires a down payment of 20% of the cost of the property. This downpayment could tie up funds and have a negative impact on your credit rating. If you do decide to finance fixed assets, it’s important to keep in mind that the TCJA limits interest expense deductions to 30% of taxable income (for a company with over $25 million in annual gross receipts).
Deciding whether to lease or buy a fixed asset has many factors to consider, including tax implications. We can help you determine the best route for your company.
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