You’re probably at least generally familiar with the concept of leasing versus buying from car shopping. But on top of considering whether you want to rent or buy, you also need to think about which one is best for your accounting. Here’s what you need to know.
Upfront Cash Flow
You generally need more cash available to buy. Even if you aren’t paying in full, you’ll probably need to make a downpayment. Leases sometimes also require a deposit or downpayment, but this is usually smaller than what you’d need to buy.
In addition to the question of whether you have enough cash on hand to buy, you also want to think about your balance sheet. Maintaining cash by leasing could help your balance sheet look healthier to lenders or investors.
Ongoing Cash Flows
With a lease, you have a fixed monthly payment for the duration of the lease. With a purchase, you only have a fixed payment if you took out a loan. In addition, if you buy, you may be responsible for the cost of unexpected repairs. With a lease, you may have the option of purchasing a maintenance plan so that any repairs are covered and you never have to pay more than the lease amount.
In addition to having free cash available, you also want to consider how payments appear to potential lenders. As with personal loans, you don’t want your debts or fixed obligations to be too high a percentage of your income. If they are, you may not be able to take on additional loans if you need to do so in the future.
If you’re trying to save taxes, leasing versus buying is situational.
Leases are easy to account for assuming they’re a true rental and not a purchase in disguise. If you’re retaining a property interest at the end of the lease, it’s a purchase not a lease for tax purposes. For a true lease, you deduct the amount of your lease payments when they happen.
Purchases are deductible as depreciation. With depreciation, it doesn’t matter if you paid everything upfront or took out a loan. You divide the value of the asset by how many years it will last and deduct that amount each year. If you want to receive a larger deduction sooner, there are special accelerated depreciation rules that may allow larger amounts in the earlier years and lower amounts in the later years. Small businesses may be able to skip depreciation and deduct certain small purchases in full in the year of purchase under an IRS rule known as Section 179.
Risk of Ownership
Leasing versus buying gives you different degrees of financial flexibility. With a lease, the asset is on your books for a certain length of time, and then it goes back to being someone else’s problem. With a purchase, if you no longer need an asset, you need to find a way to sell it or may possibly need to pay to dispose of it.
The main risk of ownership has to do with how long it takes you to recoup your investment. Since leases are shorter term, you can usually confidently take on a lease knowing that the benefits will outweigh the costs based on your near-term projections. When you own an asset, there will come a time where you no longer need it, it’s obsolete, or it’s not cost-effective to repair it. If this happens sooner rather than later or your long-term projections were off, you may take a financial loss.
Leasing and buying each have their own practical benefits, but they also have accounting impacts as well. Choosing one over the other may make your financial statements healthier if you’re trying to get a loan. They also have different types of risk that may be right for different situations. If you’re deciding whether to lease or buy, consider asking your accountant for their take on what you should do.