Equipment Purchasing Lease or Buy?
Acquiring expensive equipment requires careful financial planning.
By Bruce Bryen, CPA
Deciding whether to buy large, expensive equipment or lease it can be a difficult choice. To make an educated business decision, laboratory owners must consider many factors. Is the technology or equipment under consideration state-of-the-art? How long before a new model is developed that is quicker, smaller, or less expensive? What is the cost of the equipment? How does it fit into the laboratory’s budget? What are the tax ramifications? Is the lease a “pure” lease, or does it have an option to purchase for some nominal amount? Will this equipment produce a product of better quality and service?
Keep It Current
Prior to purchasing or leasing a big-ticket item, one of the most important issues to consider is the rate at which the technology is changing. If rapid technological advances in a product category have historically been the norm, new iterations may be introduced in the near future. If the equipment is constantly changing, then it may be obsolete shortly after purchase. Usually, the goal of buying a piece of equipment is to hold the asset long enough to pay off the financing and get a return on the investment after the final payment. When technology changes rapidly, that holding period gets truncated, and leasing might be the better option. You should also talk to vendors about their policy on upgrades as part of a lease or purchase. If you purchase an upgradeable product, you can often avoid the hassle and expense of buying a brand new piece of equipment.
Price Versus Cost
Before you consider a lease or purchase, find out the equipment’s final price. An outright purchase with conventional financing breaks down into a monthly payment of a certain amount. On the other hand, “pure” lease acquisition ensures a payment that is typically much lower.
Take, for example, the decision to buy or lease a new automobile. When buying a new car, the price paid is the fully negotiated amount that the buyer and dealership agree upon. Financing usually takes place, and the monthly payment is based on the full net price.
On the other hand, if that car is leased under a “pure” lease agreement, the salvage or residual value of the car is not included in determining the final price. That means the car is returned to the dealer at the end of the lease, and the lessee has completed his or her obligation. If a car has a net hypothetical price of $30,000, the monthly payment to buy the car at an interest rate of 6% for a 3-year term loan is $912.66. At the end of 3 years, the buyer owns the car and does not have to make any more payments. If the car continues to function well, there is a timeframe in which the owner has no payments and full use of the car.
If the car’s residual value is $10,000, that value is subtracted from the net price of the car, and the lease payment would be based on a $20,000, 3-year amortization, or a monthly payment of $608.44, assuming a 6% interest rate as described with the purchase. At the end of the lease term, the car is returned to the dealer and the owner’s obligation is fulfilled. In this example, there is a savings of $304.22 per month for 36 months, or a total savings of $10,951.92.
This same example can be used to formulate the difference between a “pure” lease on a $30,000 piece of equipment or purchase using the same terms and financing costs. The “pure” lease is different than a lease, with a nominal payment at the end of the agreement that allows the equipment to remain with the laboratory owner. In this case, a “lessee” buys back the equipment for $1, even though the paperwork states that a lease is in effect. This type of transaction is actually a purchase, and should be reported on the books as a purchase not a lease.
Purchasing big-ticket equipment provides certain tax benefits thanks to the Small Business Jobs and Credit Act of 2010. A direct tax write-off of up to $250,000 is allowed this year. Next year, up to $500,000 can be deducted for equipment purchases meeting certain guidelines regarding profit and total acquisition cost for the year. If the purchase price of the equipment is not written off this year or next, huge write-offs can be taken in the years ahead. Based on the buyer’s tax bracket, these write-offs can save hundreds of thousands of dollars in 2011, or in later years if not taken in 2011.
Again, a lease with a purchase option for $1 is not considered a lease for tax purposes and is counted as a purchase. The “pure” lease means that the equipment is turned back to the leaseholder at the end of the term, and a new lease is renegotiated on the latest version of that equipment, if the leaseholder wishes to continue with it. A “pure” lease allows the write-off of the lease payments when they are paid with a lower cost per month than an acquisition payment.
There are many questions to consider when making an informed decision regarding equipment. Because certified public accountants have expertise in cash flow, tax considerations, technological advances, and the ability to finance the lease or purchase, they are an excellent resource for potential buyers who need advice.
About the Author
Bruce Bryen, CPA, is managing partner of Bryen & Bryen LLP, Certified Public Accountants in Marlton, New Jersey.