Tax Advantages of Leasing Equipment vs Buying It
Companies with high equipment costs will often benefit from the tax advantages of leasing equipment rather than buying it. Several provisions in the tax code make leasing the most favorable option for many businesses.
It's best to work with a tax professional before signing up for significant asset purchases or leases in your business. Discussing the tax implications of leasing equipment vs buying it will help you ensure the most favorable outcome in the short and long-term.
Tax Benefits of Leasing Equipment
The potential tax benefits of equipment leasing vary depending on the lease agreement and the value of the lease. A tax planning professional can explain which of the following tax advantages applies to the equipment lease you are considering.
1. Section 179 Deduction
According to Section 179 of the tax code, small businesses can deduct the entire cost of qualifying leased equipment in the same tax year the lease started. However, this tax deduction is subject to some limitations. For example, the Section 179 deduction is limited to $1,220,000 for the 2024 tax year. Equipment must also meet IRS requirements to qualify for this deduction.
Please note: The Section 179 deduction isn't limited to leased equipment. Companies that purchase equipment can also apply Section 179.
2. Lower Taxable Income
Lease payments can typically be deducted as an "ordinary and necessary" business expense each year of the lease. This lowers your taxable income. Small businesses can deduct lease payments from their taxable income for improved cash flow.
3. No Depreciation Recapture
Leasing equipment shields you from the costly depreciation recapture implications you may face when selling equipment you purchased outright. Depreciation recapture occurs when businesses are required to repay the relevant portion of tax deductions they previously claimed for depreciation when they sell an asset for more than its adjusted cost basis.
Depreciation recapture is one of the biggest tax implications of selling business property and something to be aware of when purchasing equipment. When a lessee returns equipment to the leasing company, they aren't subject to depreciation recapture.
4. Sales Tax Savings
Businesses must typically pay sales tax on top of the price of their equipment when they purchase equipment. However, leasing equipment means sales tax is spread out over the lease period. This also contributes to improved cash flow, especially when the equipment in question is a high-ticket item.
Potential Downsides of Leasing Equipment
Consider the following downsides to leasing equipment:
Limited ownership: You don't own the asset at the end of the lease term. This means you won't have the option to sell or dispose of it as you wish.
Lack of flexibility: You may be restricted in terms of how you can use the equipment, and there may be limitations on modifications or upgrades.
Cost: Leasing equipment can exceed the total cost of owning assets over time.
Tax Benefits of Purchasing Equipment
There are also tax advantages to purchasing equipment. Purchasing equipment can benefit your business in the following ways:
Depreciation Deductions
The cost of purchasing equipment can be spread over the equipment’s useful life through depreciation deductions. Depreciation allows businesses to deduct a part of the equipment’s value as an expense every year. For example, medical equipment depreciation is a key way for businesses in the medical field to lower their taxable income.
Section 179 Deduction
The Section 179 deduction also applies to equipment purchases. The significant tax savings offered by Section 179 encourage businesses to invest in new equipment.
Bonus Depreciation
Bonus depreciation is a tax incentive that allows businesses to deduct a larger portion of the cost of qualifying assets in the year they are placed in service. Its function is similar to Section 179 but there are some key differences. Bonus appreciation allows businesses to deduct 60% of the cost of qualifying assets acquired and placed in service during the 2024 calendar year with no annual limit.
Pro tip: You may be able to use Section 179 and bonus depreciation together. Ask your tax professional how to use these deductions in the most favorable way for your business.
Potential Downsides of Buying Equipment
There are three main downsides to buying equipment over leasing it: upfront cost, obsolescence, and maintenance costs:
Significant upfront cost: Purchasing equipment requires a substantial upfront investment.
Risk of obsolescence: Technology and industry standards change rapidly. This makes it risky to invest in equipment that may become obsolete before the end of its useful life.
Maintenance costs: Owning equipment means you're responsible for maintenance and repair costs.
How to Choose Between Leasing and Purchasing Equipment
Take the following factors into account when deciding whether to lease or purchase equipment:
Cash flow: Leasing is a better option if preserving your cash flow is a priority.
Longevity: Find out the expected useful life of your equipment. Purchasing it may be more tax-favorable thanks to depreciation deductions if you use it for many years.
Industry and technology: Some industries must frequently upgrade their equipment to keep up with rapidly advancing technology. Leasing offers more flexibility in these cases.
Long-term use: If you plan to use the equipment for an extended period, owning it can be more cost-effective in the long run.
Potential for appreciation: Certain types of equipment, like real estate or specialized machinery, may appreciate in value over time. This makes it more appealing to purchase these kinds of property rather than leasing them.
Control and flexibility: As the owner of purchased equipment, you have complete control over the asset and can modify or dispose of it as needed.
Optimize Tax Savings on Your Equipment
Leasing equipment is a great way to make tax savings and free up cash flow. Small businesses can make more manageable payments over time by leasing equipment rather than purchasing it outright.
Your tax professional will help you identify all the potential tax benefits available if your business leases equipment. Knowing how to deduct lease payments in the most tax-favorable way will help you optimize your tax bill throughout your business journey.
