Having the equipment, you need to run your business optimally is essential. The right equipment can help increase productivity while also improving safety and security. Overall, getting new equipment can have a positive impact on your bottom line by increasing revenues and tax savings while decreasing workers’ compensation, repair costs, and other business expenses. How you arrange to obtain the equipment you need depends on your situation after considering tax rules and other factors.
One example of consultative partners for equipment financing is Wheeler Financial from Pitney Bowes Inc. Wheeler Financial can help assess your equipment financing options and determine solutions that work for your business.
The difference between buying and leasing - Like the difference between purchasing a house or renting one, in the first situation you own property while in the second you merely have the use of it for a set term. In business, however, the decision on whether to buy or lease equipment turns on more than just ownership. Tax treatment is discussed later, but other factors to consider include:
Technology. Initially, it makes no difference whether you buy or lease equipment, but in the long run there can be a significant difference. Because of advancements in technology, certain medical devices, construction and manufacturing equipment, and other expensive equipment may have a limited lifespan as newer and better options are developed. Consider what the future of AI and robotics may mean for your upcoming equipment needs.
Cash flow. Leasing usually is less costly, especially when it comes to upfront costs. Thus, there’s less drag on your monthly cash flow. But it all depends on the terms of the lease; the cost differential between buying and leasing may not be significant.
Balance sheet. Buying equipment puts an asset on your balance sheet. Of course, if you finance the purchase, you also carry the debt on your balance sheet. Under accounting standards, equipment leases that are one year or longer must be listed on the balance sheet (called a right-of-use—ROU—asset). This rule applies starting in 2020 for privately held companies reporting on a calendar year basis (fiscal year companies with their years ending after December 15, 2019).
Tax treatment of buying versus leasing - If you lease equipment, you can deduct all your lease costs. (There are special rules for leasing passenger cars, light trucks, and vans for your business which are not discussed here.)
If you finance the purchase of equipment, you can only deduct interest payments (not principal). What’s more, if your business does not qualify for the small business exception (for 2020 it means having average annual gross receipts in the three prior years not exceeding $26 million), then your total interest expense deduction for the year may be limited.
If you buy equipment, write-offs for the cost can be handled in different ways. Each of the following options apply whether the equipment is new or pre-owned and whether you finance the purchase in whole or in part. None, of course, apply to leased equipment because you don’t own it:
Elect to use first-year expensing (“the Section 179 deduction”). You can deduct the cost of equipment bought and placed in service in 2020 up to $1,040,000. If total equipment purchases for the year exceed $2.59 million, then expensing phases out.
Use bonus depreciation (“special depreciation allowance”). This is 100% of the cost of equipment bought and placed in service in 2020. You can elect not to use this write off if you prefer. The election out of bonus depreciation is made per class of equipment (e.g., 5-year; 7-year), so you can use this type of write-off for some equipment purchases but not for others. Forgoing bonus depreciation is favorable if 2020 is not a good year, allowing you to use regular depreciation allowances (explained next) in the future when you’re more profitable so they’ll produce greater tax savings.
Claim regular depreciation. This is an annual allowance over the recovery period for the type of equipment. Generally, equipment falls into a 5-year or 7-year class, but due to certain special rules, it means depreciation is claimed over 6 or 8 years.
Use a de minimis safe harbor rule. For inexpensive equipment, such as a smartphone or tablet, you can choose not to capitalize the cost (you don’t put the equipment on your balance sheet) and instead deduct the cost as if it were nonincidental materials and supplies up to $2,500 per item or invoice (big companies with an “applicable financial statement” such as an audited financial statement have a $5,000 cap). This option must be elected by attaching your own statement to the return. And using it for this type of equipment doesn’t reduce your ability to use greater write-offs for costlier equipment.
Conclusion - Whether you decide to buy, or lease equipment depends on your situation. It’s advisable to have your company CFO, your CPA, or other tax adviser run the numbers to determine which option is more favorable to you.
Speak to your bank, or a specialized equipment financing provider, such as Wheeler Financial from Pitney Bowes, to determine the best fit for your particular situation.