Equipment leasing can be a convenient way to access the machinery your business needs. When you lease equipment, you rent it from a leasing company, commercial vendor, or even a lender who owns the asset (known as the lessor). The agreement allows you (the lessee) to use the equipment for a set period of time while making regular payments. When the lease period ends, you return the equipment to the lessor. Some agreements give you the option to buy it at the end of the lease.
This arrangement can be practical if you only need the equipment for a short while or prefer not to take out a loan for purchasing. Equipment that’s commonly available for lease includes vehicles, machinery, and specialty appliances.
Key Points
• Operating and finance leases are the two main forms of equipment leases; each has its own set of advantages and drawbacks.
• Items that are commonly leased include vehicles, heavy machinery, or other specialty equipment.
• Leasing gives businesses financial flexibility; it allows them to conserve capital by avoiding lump-sum down payments on equipment.
• Lessors generally approve leases based on a business’s longevity, creditworthiness, cash flow, and profitability.
• At the end of a lease, the lessee can return the equipment or purchase it, often at a reduced price.
Types of Equipment Leases
There are two basic types of equipment lease: operating leases and finance leases (also called capital leases). Related arrangements, such as sale-leaseback agreements, exist to provide additional financial flexibility.
Operating Leases
An operating lease is similar to a rental contract. It allows a business to lease equipment for a set period of time without necessarily purchasing the equipment at the end. Instead, ownership of the equipment stays with the lessor, who may also maintain and insure the equipment. Operating leases sometimes provide for early termination of the contract but may charge a hefty penalty.
Capital Leases
Capital leases — now also known as finance leases — are designed to be a pathway to ownership. Your business pays to use the equipment for a set period of time, and at the end of the lease term, you’d typically purchase the equipment. A capital lease is usually non-cancellable.
Sale-Leaseback Arrangements
With a sale-leaseback, you sell a piece of equipment and then lease it back from its new owner. You don’t even have to relocate the equipment. The advantages of this arrangement: It frees up working capital for your business and can help improve your balance sheet. There’s no need for a business line of credit, as you can use the sale proceeds to expand, hire additional employees, or build new products.
However, depending on the terms of the lease, the company may have to forgo some tax benefits. Be sure to consult a CPA or other tax professional about whether a sale-leaseback is appropriate for your business circumstances.
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Equipment Leasing vs Buying
When deciding on leasing vs. purchasing equipment, look beyond the monthly payment amount. If you need the equipment for only a short period of time, leasing can be a good choice. It may also be practical if the equipment changes rapidly with new technology, like computers or certain medical devices. Leasing gives you the flexibility to upgrade to newer models more easily without worrying about the sunk cost of owning the older version.
Leasing can also be preferable for certain types of businesses where the equipment is large and expensive. For example, farmers may not have the cash flow to support big payments on farm business loans for tractors and harvesters.
However, over the long term, buying is usually cheaper than leasing. If the equipment is unchanging and durable and you expect to need it indefinitely, small business financing may be a more prudent choice.
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Tax Considerations
Given variations in state and local taxes, your lease arrangements could affect your tax bill. Check with your leasing company and your tax attorney or accountant for specifics. Some issues to discuss might include the following:
• Are your equipment lease payments deductible on your federal or state taxes?
• Does your state or local government assess tangible personal property taxes on rented or leased equipment?
• If you have a finance lease, are you considered the owner for tax purposes?
• If so, can you claim the equipment’s depreciation on your federal or state tax return?
• If you have an operating lease, can you claim depreciation on your federal or state tax return?
Qualification Requirements
Lease requirements will vary depending on the lessor, but most leasing companies consider things like business history, credit scores, cash flow, and profitability.
With leases and loans, companies with longer track records often get approved more easily than startups. So new firms may want to compare their lease options to possible purchases through startup business loans.
Equipment financing companies, lessors, and lenders can vary in their opinions of acceptable credit scores. Business owners with low credit scores may want to explore bad credit equipment financing options.
Even applicants without high credit scores may be able to qualify for a lease or loan if their company’s finances are strong enough. Evidence from the business’s recent financial documents, such as income statements and tax returns, can boost the chances of approval for a lease or equipment financing.
Payment Structures
Equipment leases may or may not involve down payments. The leases usually offer fixed interest rates for the duration of the contract. The rates depend on your credit, the lease term, and the type of equipment, among other factors.
You can expect to pay other costs when leasing equipment, such as delivery, maintenance, and installation charges; appraisal fees; insurance; and state and local taxes or fees.
End-of-Lease Options
Finance leases, once known as capital leases, generally allow the lessee to purchase the equipment at the end of the term. You may be able to buy it for far less than the fair market value, especially if you had what’s known as a $1 buyout lease.
If you have an operating lease and don’t want to buy the equipment at the end of the term, you simply return the item to the lessor.
Most equipment lease agreements will spell out rules for canceling the lease before the term ends. Operating leases often give you the option of early termination, but you’re likely to be charged a hefty fee.
The Takeaway
Equipment leasing for your business can be practical in many situations, such as when you need the equipment only temporarily or when the technology is upgraded frequently. Leasing equipment is cheaper upfront, as a down payment may not be needed, but over the life of the lease, the total outlay may exceed the purchase price. Lease agreements may affect your balance sheet and tax bill, so consult your accountant or other tax professional before you decide.
If you’re seeking financing for your business, SoFi is here to support you. On SoFi’s marketplace, you can shop and compare financing options for your business in minutes.
FAQ
What’s the difference between an operating and a capital lease?
Capital leases, also known as finance leases, are designed as a pathway to ownership. Canceling a capital lease can be very difficult and expensive. Operating leases are more similar to rental contracts. You are generally able to cancel the contract early with an early termination fee.
How do I qualify for equipment leasing?
Qualification requirements will vary by the leasing company, but most consider facts like the business’s years of operation, credit scores, cash flow, and profitability.
What happens at the end of the lease?
At the end of many operating leases, you return the equipment to the owner. Capital leases, now known as finance leases, enable the lessee to buy the equipment when the lease concludes.
Can I buy the equipment after the lease?
Many lease contracts give you the option to purchase the equipment at the end of the term, especially finance leases. The price you pay at that time may be the fair market value, or it may be less. If you don’t want to buy the equipment, you simply return it to the owner.
Can I upgrade equipment during the lease term?
Yes, you may be able to upgrade equipment during a lease, depending on the type and terms of the contract. In fact, being able to upgrade equipment easily is a significant advantage of leasing.
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