Last year, we worked with a new business owner hoping to expand his home remodeling business. As an experienced painter and contractor, he wanted to offer additional services. The problem was he was running low on cash reserves.
Our tax preparer noticed a lot of expenses for equipment and began to ask more questions. This is a common problem for service-based businesses; unless he got his expenses under control, he wouldn't be in business for long.
He needed to learn about a strategy that could save his business: to lease or to buy, that's the question.
Let's start with buying equipment, which may be easier than leasing because a lease may involve more paperwork, including financial information.
If you buy the equipment, you own it. You can use it for as long as you want and you can depreciate the cost on your tax return. The equipmentmay qualify for a section 179 deduction which may allow you to deduct some or all of the cost of the equipment from your taxes in the first year.
Or you could choose to depreciate the cost over a prescribed number of years. Depreciation is the annual deduction that allows you to recover the cost (or other basis of your business) by spreading it over a certain time frame. You may be able to use a combination of section 179 and depreciation to better adjust your taxable income from the business.
Depreciation starts when you first use the property in your business or for the production of income. It ends when you take the property out of service, deduct all your depreciable cost or basis, or no longer use the property in your business or for the production of income.
Plan to work with your tax preparer on this. Your business may need to provide a large initial outlay (to offset income) or use lines of credit.
Owning the equipment means you can sell the equipment at any time or continue to use the equipment for as many years as it remains productive.
Some equipment will eventually become obsolete and you will sell it or convert it to personal use, which may have tax consequences. You can also donate it to a charitable organization and take a deduction on your personal tax return.
On the other hand, leasing equipment can free up more capital for other investments, without sacrificing the quality of the equipment. This can be crucial in the first few years of business.
Leasing can give you the latest technology and, generally, will cost less money upfront. In the long run, however, leasing is usually more expensive.
Depending on your lease you may not be responsible for maintaining the equipment. The lease payments for business equipment are usually deductible.
Unfortunately, there are several types of leases. Some are actually conditional sales contracts and are not deductible. They are considered to be part of the "purchase price" and the asset is recovered through depreciation.
Again, run these numbers by your tax pro, so you know what you are getting into and the expenses aren't running you out of business. It's all about cash flow, smart tax strategies and planning for a business that will be around for many years.