Proper equipment is essential for performing your work and delivering on your contracts. However, the high cost of equipment can hamper your bottom line in the longterm if you haven’t chosen the right avenue of financing for your situation. Don’t become consumed with the old concept of buying all of your equipment upfront. There are a variety of rental and leasing options available today, each with its own financial perks.
With today’s lower interest rates, leasing has evolved as a favorable option. Leasing is an interval-based payment option, usually lasting at least one year and offering incentives and benefits such as:
- No down payment requirements
- No direct debts
- Flexibility to purchase equipment in full at the completion of the lease or return equipment, commonly referred to as an “open-end lease”
Accounting For Your Lease
When considering leasing equipment, it is important to know that there are two types of leases that can be recognized for accounting purposes:
1. A capital lease is similar to a purchase, although not legally deemed as such. It has the economic attributes of owned assets, thus for accounting purposes, consider it a purchase. As part of this lease, you are viewed as the owner of the equipment, meaning your equipment will be accounted for as an “on the balance sheet” asset on your financial statement. Tax deductions are made regularly until the leasing period is complete or the lease has been paid in full. These deductions for the equipment are limited to the depreciation of the equipment and the interest portion of the lease payments.
2. An operating lease acts as a rental agreement – a contract that allows you to use equipment without conveying ownership rights. It is accounted for as an “off the balance sheet” asset for financial statements. Since it is not held as a liability, you can maintain a low debt-to-equity ratio and increase your ability to borrow more equipment with ease. Payments on equipment under an operating lease are eligible for annual tax deductions. Standards have been established by the Financial Accounting Standards Board (FASB) that qualify equipment under a capital lease or an operating lease. Each of these types of leases require different accounting treatments, so be sure you understand the qualifications of each.
For those not intending to use equipment for a long period of time, or simply wanting to cut costs, renting is another alternative providing several incentives, including:
- Short-term agreements, i.e., monthly, weekly or daily
- Fewer financial constraints
- More options if you have poor credit
- Ability to test out machinery in advance
Accounting For Rented Equipment
As opposed to taking out a loan to buy equipment and affecting your credit-to-debt ratio, renting is considered a separate transaction and will not count against current debt. It enables you to expense costs immediately and is applied against your taxable income. In addition to no tax on rental equipment, there are no hefty guidelines aligned with accounting for equipment.
If you are convinced that having complete control of your equipment is the only way to go, then buying is the best alternative for you for a few reasons:
- Ability to manage how equipment is maintained
- A cost savings of 20 percent to 30 percent over leasing in the long run, since there are no related fees attached to buying
- Tax breaks – by deducting some of the purchase price on a tax return, some of the payment can be reimbursed
Accounting For Purchased Equipment
Tax advantages of buying equipment aren’t as great as in recent years thanks to the expiration of two favorable tax provisions:
- Special 50 percent first-year bonus depreciation available before 2014 for certain qualified property is no longer available for most types of property.
- The elective Section 179 expense deduction has been reduced from $500,000 to $25,000 a year starting this year.
Congress may extend these tax breaks and make them retroactive to Jan. 1, 2014, but it’s currently too early to tell.
A hasty equipment purchase can lead to a lengthy financial burden, so take the time to evaluate and get the most bang for your buck.