The Tax Implication of Leases for Your Business
By Scott Boyles, Chief Lending Officer
You’ve probably been thinking about your 2018 taxes as of late. However, now’s the perfect time to start making decisions for 2019––especially when it comes to leases.
Farmers & Merchants Bank offers leases on equipment and buildings, and that’s of particular importance if you’re thinking about any upcoming purchases. Your choice will impact your future taxes.
Leases vs. Loans
A lease sets up monthly payments that permit you to use equipment or property. When the lease ends, you typically have the option to buy the item at fair market value, or return it.
Leases are a tax-effective way to acquire the use of expensive items––especially when an outright purchase is not necessary for your business operations. Here’s why: 100% of all lease payments can be deducted for income tax purposes. And that’ll help increase the speed and amount of the write offs and improve your bottom line.
On the other hand, a loan to purchase property or equipment creates tax deductions through depreciation and interest costs. Depreciation stretches the deductibility of the investment over the IRS-determined life of the item purchased, which can be decades long. With loans, write offs are minimized and deducted over many years.
A lease allows for a complete tax write off of interest and cost of the item over the lease term. For example, if a farmer leases a piece of equipment under a five-year lease, the value of that equipment, plus accrued interest, is written off over a five-year period. In addition, since the first lease payment is made at closing, that amount can be written off immediately.
With a loan, farm equipment is depreciated over seven years. So, a five-year installment loan for equipment will not change the requirement that the property must be depreciated over a seven-year term.
The advantage of a lease is even more pronounced with the purchase of a building or grain storage unit. That’s because a building has a 39-year class life, which means the value of the building would be depreciated over 39 years. The interest on the loan to purchase the building would be deducted annually.
If, however, the building is leased over a 15-year term, the value of the building, plus accrued interest, would be written off over 15 years. That’s a far cry from 39 years. In addition, since the first lease payment is made at closing, that amount can be written off immediately. The cost of the building could be written off almost twice as fast, in this example, using a lease.
Contact your tax advisor
To lease or not to lease? It’s an important decision when figuring out how to pay for big ticket items. The information provided above represents only an estimate of the effects of a lease compared to a purchase with a loan, and neither the Bank nor its employees are tax experts. It’s wise to talk with your tax consultant before deciding what’s best for your finances.