As a small business owner, you have too many tasks to handle besides worrying that your equipment will leave you in the lurch. But upgrading your business equipment – whether brand new or pre-owned – can lead to a significant financial decision. You’ll usually have to decide between equipment financing, where owners take out business equipment loans to purchase the equipment outright, or leasing the equipment to keep cash flow steady.
Whichever you choose, these options will get you the tools, machinery, vehicles or other equipment you need to keep your day-to-day tasks on track. Let’s explore these options and break down when equipment financing or leasing is more appropriate for your business needs.
Many small business owners simply don’t have the cash on hand to purchase new equipment outright or they don’t want to create cash flow problems – that’s when leasing a piece of business equipment can come in handy. By leasing, you’re basically renting the equipment, just like if you lease a car from the dealership. Your lender purchases whatever piece of equipment you want – a new computer, a dump truck, etc. Then you make payments to the lender of finance company to use that equipment. When your lease term ends, you can choose to renew it, end it or in some cases outright purchase the equipment.
Leasing can be a good option for businesses that frequently update their equipment or technology because the lease payments allow you to keep your cash in reserves and pay less while always having new, updated equipment. The Tax Cuts and Jobs Act, passed in December 2017, includes a change that makes leasing even more attractive.
According to the IRS, lease payments are 100 percent deductible with no limit. Interest on loans is now only deductible on up to 30 percent of earnings for companies with revenue great than $25 million. So if your business revenue is greater than $25 million and you’ve traditionally deducted 100 percent of interest payments, it may be a good time to consider leasing instead of paying more taxes.
However, as you’re debating equipment leasing vs financing, it’s important to acknowledge the potential drawbacks. One reason leasing may not be the best choice is because you never actually own the equipment you rely on. As a result, you can’t sell it to recoup some of your upfront costs. Leased equipment helps your business operations, but it’s not an actual asset on your balance sheet.
Lease agreements also typically include terms of usage dictating how you’re allowed to utilize the equipment. For example, when you lease a car you’re expected to keep it in good shape, have all maintenance performed on schedule, and keep the number of miles you drive below a certain threshold. There can be similar terms for equipment leasing. You may find these restrictions limiting, so much so that they diminish the utility and value of new equipment. If you do violate the terms of usage, there can often be significant financial penalties, as well.
Since every lease agreement is different, it’s important to carefully scrutinize the details before signing on the dotted line. Some agreements are better than others, and you won’t know exactly how a lease will affect your business until you take a look at the exact terms.
If you decide to purchase and financing your equipment, considering business equipment loans may be a good option, especially if you don’t need to update equipment regularly and plan to use the equipment for a long period of time. In this case, your business is the owner of the equipment and you make payments to your lender, just as you do with a home mortgage.
The new tax law also offers a change in depreciation rules that can make equipment purchases – rather than equipment leasing – more attractive to some companies. Formerly, when a business purchased equipment or machinery the owner could not deduct the entire expense from the taxable income for the year the purchase was made. Instead, businesses were required to depreciate the expense of newly purchased equipment or machinery over a number of years. With the new tax law, business owners can deduct 100 percent of the expense of equipment purchased during the same year under a rule called Section 179.
This rule was specifically created to spur on small business economic activity by making new equipment more attainable. Under Section 179, businesses can deduct up to $1,000,000 in equipment costs. If you purchase more than $2,500,000 worth of equipment the deduction begins to go down, which underlines the utility of these rules specifically for small businesses.
Small businesses can easily take advantage of Section 179 because the deduction applies no matter how the equipment is purchased. That means you can take out small business equipment loans to get the required capital, then deduct all or most of the loan amount from your taxes that year. It’s a win-win for small businesses because they get the equipment they need to grow, yet they’re able to reduce their tax bill in the process. Section 179 applies to most common times of “business equipment”, but there are exceptions, so be sure to verify that any purchases you intend to make are eligible for the tax deduction.
Final Verdict – Equipment Leasing vs Financing
Both options are attractive for different reasons. Instead of assuming that one or the other is best for your business, dive into the details. Figure out what kind of equipment your business needs to reach the next level, the explore the economic impact of that specific equipment if you choose to lease vs if you choose to take out small business equipment loans. You may be surprised by what you discover, especially when you look at the return on investment of the new equipment over the long term. No matter which option you choose, you’re doing something positive for y our business by acquiring the equipment it needs to thrive and grow.
If the state of your current equipment lease your day-to-day work open to interruption, it’s likely time you investigate one of these options. Whether you opt for financing or leasing, upgrading your equipment can leave you with the peace of mind to focus on reaching out to new potential customers rather than calling your nearest repair shop.