Business owners are faced with dozens of critical financial decisions each and every day. Whether the line item is employee benefit costs, inventory management, marketing budgets or cost of goods and services, each decision ultimately must take into account the one business metric that dictates virtually all planned and unexpected expenditures: cash flow. The health of your business depends on it, and it is a key decision driver when the time comes to invest in infrastructure, equipment and products that your business requires. Your friends at Union Savings Bank have curated this blog to speak to your concerns.
As you’re considering bigger (or even your first) office space, that new multi-function printer/copier, an upgrade to your service truck fleet or a furnishings facelift for your retail store, you’ll all need to decide whether it makes more sense to lease or buy. I’ve counseled businesses both large and small over the years, and there are a number of additional considerations you should keep in mind before you decide on a financing option. Typically, in addition to cash flow, potential tax benefits and how often technology changes are top decision drivers. Here are the six topics that I’m most often discussing with business owners:
1. Why Growing Businesses Should Lease
Leasing is generally a very good idea if your business is in growth mode. If you’re a start-up and anticipate much more staff in short order, don’t lock yourself into a current location. Depending on your success, you may need more square footage fast. You may even find that staffing needs for your expanding business require a relocation to attract that top talent. New space may also require different office furnishings. Buying property as a business can weigh you down. Leasing will ensure that you’re able to move and reconfigure your business environment quickly.
2. When Equipment Purchases Can Save You Money
Conventional wisdom often favors leasing business equipment, but it’s not always a good idea. Given the pace of technical innovation, do you really need to spend time worrying about traditional concerns, such as disposal of old technology, that owners used as a case for buying? Common business equipment, such as computers, servers and printers, have become relatively affordable that they are simply easier to replace every few years. So, purchasing and taking the immediate tax savings may be wiser than entering in a lengthy lease arrangement for equipment that may become outdated very quickly.
When it comes to heavy duty copiers, printers and fax “all in one” type equipment, the answer to “lease or buy?” can be that leasing is best since these tend to be pricier and require a service contract to maintain on a regular basis. Many leases have favorable terms that come with service contracts for the equipment. Leasing also allows you to swap out for newer models.
3. Saving Even More Money with Big-Ticket Buys
Current tax law allows immediate expensing under Section 179 up to $500,000 for qualifying tangible business property– a significant tax benefit if you’re investing in costly items, such as medical equipment or big manufacturing machinery. Buying instead of leasing expensive equipment is an especially sound option for established businesses since you’ll obviously need to allocate capital for such an investment or have excellent credit to secure financing for the purchase. Given all the other increases in taxes that today’s companies are subjected to, this deduction is nonetheless a compelling reason to buy instead of lease. Do keep in mind that the business assets purchased must be placed in service during the year in an active trade or business and where the property is used predominantly for business purposes versus personal use.
4. When the Topic is Wheels, Leasing is the Smarter Choice
One of the most common discussions I have with clients is whether to lease or buy vehicles. If your business involves a fleet of service vehicles, work trucks, or personal vehicles for your field sales team, definitely consider leasing. Vehicles that get hard usage tend to be replaced more frequently, so leasing ultimately could save you money on maintenance and repair, depending on warranty terms. Also for cash flow purposes, auto/vehicle leasing tends to be more favorable on the cash flow needs of a business for an asset that tends to significantly depreciate over a few years. For tax purposes, to lease or buy a luxury auto has similar tax advantages and there is no significant tax benefit to owning versus leasing an auto due to certain tax limitations to deductibility of luxury automobiles.
One important caveat: many leases are based on usage, such as vehicle mileage or volume of copies. To avoid getting blindsided by incremental costs, be sure you project your expected usage before you sign on the dotted line. And, as with purchases, make sure business vehicle leases are used for exactly that purpose.
5. When Buying the Building Makes Sense
If you are an owner of an established operating company, you and your partners should consider whether to buy commercial property: buying the commercial space your business occupies and lease it back to the business. If you do purchase the building or commercial space, the building should be held in a separate entity outside the operating business. There are the obvious tax benefits, such as depreciation, but the biggest reason is for legal protection. We live in a litigious world and lawsuits for any number of reasons against your business can and often will happen. You’ll want to protect the operating company from the building and vice a versa from that risk – and potential ruin.
The benefits of depreciating commercial property over time will provide tax relief – real estate property takes a long time to depreciate (typically 39 years). However, if you were to initiate a cost segregation study it is possible to accelerate depreciation over a shorter time horizon. This type of study requires a vast array of professionals to determine individual components existing in a building– such as parking lots, walkways and landscaping – that can be depreciated over 15 instead of 39 years. Other categories, such as lighting fixtures and HVAC systems or other mechanicals to the building, may be depreciated over seven years.
While these are “big business” lease or buy decisions that you may not have to worry about right now, be aware that success will only add complexity to your financial management strategy. Of course, that’s a good problem to have!
6. Look Before You Leap, Lease or Buy
Before you make a major lease or buy decision, check with your accountant, tax adviser or CPA. If a contract is involved, add your attorney to the mix. Deciding whether to lease or buy ultimately depends on your unique situation, so there’s usually no right or wrong answer. This list of considerations should at least help you think about the pros and cons of your individual choice.
Written by Ben Maini, CPA
Partner, Reynolds & Rowella
New Canaan, Connecticut