To Lease or Buy Equipment

As the economy continues to improve, more construction businesses are making capital investments to fuel their growth. When business owners and managers consider acquiring equipment, they often think of their payment option as a “lease versus buy” decision. In any economic environment, when preserving owner or shareholder capital is an important goal, financing equipment through a lease or loan will enable your business to preserve its cash.

Whether you finance equipment through a lease or loan, each has its advantages. In evaluating your options, it is important to look at each alternative to determine which will best balance usage, cash flow and your financial objectives. To help determine the most appropriate option, consider the following questions:

1. How long will the equipment be required?

Generally speaking, if the length of time the equipment is expected to be used is short term (36 months or less), leasing is likely the preferable option. Equipment expected to be used for longer than three years could be a candidate for a lease or a loan.

2. What is the monthly budget for the equipment?

As with any ongoing business expense, consider the monthly cost for a piece of equipment and how it fits into your budget. In general, leasing will provide lower monthly payments.

3. Will the equipment become obsolete while it is still needed for the operation?

Protection against obsolescence is one of the many benefits of equipment leasing because the risk of obsolescence is assumed by the lessor. Certain lease financing programs allow for technology upgrades and/or replacement within the term of the lease contract.

4. Is the equipment going to be used for a specific contract or can it be used for other projects?

Often, the business objective of equipment is for it to be revenue-producing. If a piece of equipment has limited use within a specific contract and won’t be used for other projects, it’s not ideal for it to be idle while you continue to make payments on it. It makes sense to stop the equipment expense when the income from it ceases, which you can do with a lease.

5. How much cash would be required upfront for a lease and for a loan?

Leasing can often provide 100 percent financing of the cost of the equipment, as well as the costs for transportation, delivery, installation set-up, testing and training, and other deferred costs (sales tax). Loans usually require a down payment and don’t include the other cost benefits. Ask how much of a down payment is needed and assess the availability and desirability of allocating company capital for that down payment.

6. Can the company use the depreciation or would the company get a greater benefit from expensing the lease payments?

The tax treatment of the financing arrangement is an important consideration in choosing between a lease and a loan. A loan provides you with the depreciation tax benefit; with a lease, the lessor owns the equipment and realizes the tax benefit, which is usually reflected in a lower monthly rent payment for your business, as well as the ability to expense the payment.

In many instances, if your business cannot use the tax benefit, it makes more sense to lease than to purchase through a loan because you can trade the depreciation to the lessor in exchange for better cash flow.

7. How will a working capital facility be impacted?

Many businesses have an aggregate line of credit through a bank that they can use for inventory purchases, improvements and other capital expenditures.

Depending on the lending covenants, it is often possible, as well as preferable, to preserve your bank working capital by leasing equipment through an equipment finance provider.

8. How flexible does your business want the financing terms to be?

A lease can provide greater flexibility because it can be structured for a variety of contingencies, whereas, with a loan, flexibility is subject to the lender’s rules.

If your business has continuing use for the equipment at lease termination, extended rentals, purchase options, trade-ups and return options are available. The lease term allows your business to match all expenses to the term of the equipment’s use, including income-tax expense, book expense and cash expense. Most importantly, as mentioned previously, the expense stops when the equipment is no longer required.

With the current low-interest-rate environment, now is a good time to finance equipment, in general, through a lease or loan. Again, the benefits of the type of financing is dependent on a number of variables and not necessarily the economics alone.

9. Do you anticipate the need for additional equipment under your financing agreement?

If your business is planning for growth, you can enter into a master lease that will allow you to acquire multiple pieces of equipment under multiple schedules with the same basic terms and conditions. This provides greater convenience and flexibility than a conditional loan contract, which must be renegotiated for additional equipment acquisitions.

10. Who can help me evaluate what’s best for my business?

Whether you finance equipment through a lease or loan, each has its advantages. When making the decision between a lease and a loan, it is highly recommended you consult with your accounting professional, as well as draw on the resources of your equipment financing provider, to enable you to secure the best possible terms for your lease and/or loan.

These are some of the key considerations that should go into the lease versus loan decision-making process. Find a lease/loan comparison and online tools.

NRCA’s President, Nelson Braddy, Responds to Proposed Legislation to Reform Cost Recovery Provisions of the Federal Tax Code

Senate Finance Chairman Max Baucus (D-Mont.) recently released a discussion draft of proposed legislation to reform the cost recovery provisions of the federal tax code. This draft would repeal the current depreciation system, referred to as Modified Accelerated Cost Recovery System, and replace it with a new system that pools assets into separate categories. The draft also instructs the Congressional Budget Office (CBO) to analyze the economic depreciation rates of tangible assets and authorizes the U.S. Department of Treasury to review CBO’s findings to determine whether assets should be reassigned depreciation schedules or whether new ones should be created.

Under the Baucus proposal, the changes in these depreciation schedules would generate nearly $700 million in revenue for the government during the next decade. This would be used to offset cutting the 35 percent corporate income tax rate. Unfortunately, Baucus’ proposal cuts tax rates for only C-corporations but not for pass-through businesses that pay income taxes at the individual rate.

The Rosemont, Ill.-based National Roofing Contractors Association supports comprehensive tax reform that boosts economic growth by substantially lowering individual and corporate tax rates. Roughly 75 percent of its members are S-corporations, limited liability companies and other pass-through entities. Cutting taxes for entrepreneurs that file at the individual rates and as large corporations is essential for the roofing industry. NRCA is disappointed Baucus’ discussion draft does not include reductions in individual income tax rates.

In addition, NRCA supports reforming the depreciation schedule for commercial roof systems. The current 39-year depreciation schedule is an obstacle to economic growth and more than double the average life cycle of a commercial roof system, which is 17 years. Baucus has proposed extending the depreciation schedule for real property, including commercial roof systems, to 43 years, which does nothing to remove the incentive for building owners to forego a full retrofit to a failing roof in favor of making only piecemeal repairs. In addition, extending the depreciation schedule will further complicate business owners’ tax decisions; do nothing to promote economic growth; and fail to advance greater energy efficiency within the commercial building sector. Baucus has stated the goal of this proposed legislation is to “establish a system of cost recovery that better approximates the decline in the economic value of an asset.” However, 43 years to depreciate a commercial roof system does not accurately represent its economic value.

NRCA is pleased to see Baucus included higher Section 179 expensing limits in his discussion draft, which would permanently increase the expensing limits to $1 million and be indexed for inflation.

Baucus has requested comments regarding the discussion draft be submitted by Jan. 17, 2014. NRCA will submit its comments to the tax code in a comprehensive manner. The association remains committed to working with lawmakers to pass progrowth tax policies that benefit the roofing industry and the economy.