Lease or buy: equipment and vehicle leasing explained
Leasing can preserve cash and make upgrades easier, while buying usually costs less over the long run for equipment you will use until it wears out. The right answer depends on the lease type, the full cost and the fine print at the end of the term.
Know which lease you are signing
Equipment leases are defined mostly by what happens when the term ends, so identify the structure before you compare payments. An FMV lease suits equipment that dates quickly, such as computers or medical devices, because you can hand it back, while a $1 buyout suits machinery you expect to run for its whole life.
- Fair market value (FMV) lease: lower payments, with the option to buy at market value, return the equipment or renew when the term ends.
- $1 buyout lease: higher payments, and you own the equipment for a dollar at the end, so it works much like a financed purchase.
- Fixed purchase option lease: a preset buyout price, such as 10 percent of the original cost, between those two extremes.
- TRAC lease: for trucks and other vehicles used mainly for business, settled at the end against a residual value set at signing.
Compare the total cost, not the payment
A low monthly payment can hide a high total cost. For a lease, add every payment, upfront amounts such as advance payments, a security deposit and documentation fees, the buyout if you plan to keep the equipment, and end-of-term costs such as shipping it back. For a purchase, add the price, sales tax, installation and financing interest, then subtract what you expect to sell the equipment for later.
Many business leases quote only a payment, not an interest rate, so ask for the rate built into the lease or work it out from the payments, fees and buyout. On a vehicle lease, a common rule of thumb is that multiplying the money factor by 2,400 gives a rough equivalent annual interest rate, so a money factor of 0.0025 suggests about 6 percent.
Who maintains, insures and keeps paying
Most equipment leases are net leases: you maintain the equipment, insure it, pay any property taxes and carry the risk of loss, even though the lessor owns it. Expect to provide proof of insurance that names the lessor as loss payee.
Many leases are also non-cancelable, often with a hell-or-high-water clause that requires payment even if the equipment breaks or no longer suits you. Warranty disputes are between you and the manufacturer, not a reason to stop paying the lessor.
Vehicle leases add mileage and wear limits. Exceed the annual mileage allowance and you pay a per-mile charge at turn-in, and dents, worn tires or interior damage beyond normal wear are billed as well, so estimate your real mileage before choosing an allowance.
Plan the end of the lease on day one
Most expensive surprises in leasing arrive at the end. Decide before signing whether you are likely to buy, return, renew or upgrade, and find each of the details listed below in the contract.
Fair market value leases often contain evergreen or auto-renewal clauses. If you don’t send written notice within a set window, often months before the term ends, the lease can roll into extra months or a full renewal term at the same payment. Put the notice deadline on your calendar the day you sign, and send notice by a method that proves delivery.
In a TRAC lease, the vehicle is sold or valued at the end. If it brings more than the agreed residual, you receive the surplus, and if it brings less, you pay the shortfall, which is the trade-off for lower payments.
- The notice deadline, and the address and method for giving notice.
- How fair market value will be determined, and by whom.
- The return location, shipping costs and required condition of the equipment.
- The cost of ending early, often most or all of the remaining payments plus the residual.
The tax picture
For a true lease, a business can generally deduct lease payments as an ordinary business expense. When you buy equipment, or sign a lease the IRS treats as a purchase, such as a typical $1 buyout lease, you generally recover the cost through depreciation instead and may deduct the interest portion of any financing.
Section 179 lets many businesses deduct the cost of qualifying equipment in the year it is placed in service, up to an annual limit that is adjusted for inflation, and bonus depreciation may also apply. Passenger vehicles face extra limits under both approaches. Which structure saves more depends on your income, timing and the rules in effect that year, so ask a tax professional before choosing a lease for tax reasons.
The accounting picture
Under ASC 842, the lease accounting standard for companies reporting under U.S. GAAP, most leases now appear on the balance sheet as a right-of-use asset and a corresponding lease liability. Short-term leases of 12 months or less can be left off if the company elects to.
That change removed one old reason for leasing, keeping obligations off the balance sheet. If your company has loan covenants or reports to lenders or investors under U.S. GAAP, ask your accountant how a new lease will affect those figures before you sign.
When leasing tends to win, and when buying does
Neither choice wins every time. Run both options over the same period, with the same assumptions about resale value, and let these patterns guide the decision.
- Leasing fits equipment that becomes outdated quickly or that you plan to upgrade on a schedule.
- Leasing fits when preserving cash and credit lines matters more than the lowest lifetime cost.
- Buying fits equipment you will use for most of its useful life.
- Buying fits when you have cash or low-cost financing and want no usage limits or return conditions.
- Either can fit seasonal or project work, if the term matches how long you need the equipment.