When Gil Grieve wanted to put two new paint booths into his shop a couple of years ago, he knew he would purchase them outright.
"Some things I'll lease and some things I'll purchase," says Grieve, owner of Concours Body Shop in Reno, Nev. "When I first started in business, I was in debt up to my eyeballs for the first seven or eight years. I was getting started and, of course, I leased everything. But once I got through that, I rethought how I make purchases. If it's something that's a real high-wear item, like an air conditioning machine, that you know is going to last four or five years, I'll lease it and depreciate it out. But big stuff – frame racks or measuring systems or paint booths – I'll just purchase."
Grieve's decisions regarding leasing versus purchasing track with what business and accounting experts generally recommend. Leasing equipment, they say, can be a better option for business owners who have limited capital or who need equipment that must be upgraded every few years, while purchasing equipment is often a better option for established businesses or for equipment that has a long, usable life.
Here's a look at the advantages and disadvantages of both options – and some tips on deciding which is best for your business.
Leasing preserves capital
Leasing equipment was a logical choice for Grieve in the late 1980s, when he was just starting out as a shop owner, because he didn't have the cash to make outright purchases. Equipment leases often require little or no down payment, so you can obtain the tools and equipment you need without significantly affecting your cash flow.
Another financial benefit of leasing equipment is that your lease payments usually can be deducted as a business expense on your tax return, reducing the net cost of your lease. Leases also are generally easier to obtain and have more flexible terms than loans for buying equipment. This can be a significant advantage if you have limited credit or need to negotiate a longer payment plan to lower your costs.
Grieve also has learned another benefit of leasing some equipment. Leasing items that have a reasonably short expected lifespan or that are subject to becoming technologically outdated in a short period of time can make good sense. It passes the burden of such obsolescence onto the lessor, because your business can walk away at the end of the lease and get a new, up-to-date replacement.
There are downsides to leasing, however, including the fact that it can cost you more in the long run. As Grieve struggled to overcome the initial debt he took on starting the business, he realized leasing equipment is almost always more expensive than purchasing it.
Say, for example, you want a piece of equipment that would cost you $7,500 to purchase outright. A lease on that item would be based on a certain dollar amount per $1,000 of value. At $40 per month per $1,000 in value, that item would have a monthly payment of $300, and over the three years, you would pay $10,800.
In addition to the higher cost, you will have built up no ownership equity in the item. So unless the item becomes virtually worthless at the end of the lease, the lack of ownership can be a significant disadvantage. Be sure to ask up front about what buyout options are available at the end of a lease.
And keep in mind that you are generally obligated to continue to make lease payments for the entire lease period even if you stop using the equipment. There are generally large early-termination fees to get out of a lease before the lease term ends.
Purchasing is often less expensive
Buying a piece of equipment outright has some obvious advantages over leasing. First and foremost, purchasing gives you ownership of the item, which is particularly beneficial if the item should have a long, useful life, such as office furniture or a paint booth.
There are tax advantages to purchasing as well. In recent years, Congress has expanded part of the tax code known as Section 179, which gives businesses the ability to immediately write off large amounts of equipment. For 2007, you can deduct $112,000 in qualifying equipment purchases. That amount is reduced only if you put into service more than $450,000 in equipment this year, although there are some types of equipment – most notably, vehicles – with more restrictive Section 179 rules.
But if cash is in short supply, purchasing may not be the best option because of the initial outlay it requires. Even if you get a loan to make the purchase, you will often be expected to make a down payment, perhaps as high as 20 percent of the purchase price. And that loan could reduce your ability to obtain other lines of credit you may need prior to it being repaid.
Business financial advisors we spoke to say shop owner Grieve has it right when he makes most equipment purchases outright, reserving leasing for times when cash is a problem and when tax advantages and the life expectancy of the item offset some of the higher costs of leasing.
Advisors say it is best to examine tax issues, overall costs, cash availability and the expected life of the equipment when deciding whether to lease equipment or buy it outright.
Before you make a big purchase or sign a lease, consult with your financial advisor to see what options work best for your situation.