To Lease Or Not To Lease?

What's Your Type

There are a plethora of lease types available to small-business owners. Two of the most popular are operating leases and finance leases. The first has a term that is shorter than the expected, useful life of the equipment because the lessee is not expected to use it for long nor do they wish to buy it at the end of the lease. Operating leases allow you to lease expensive equipment at a fraction of its total purchase price.

Much simpler is a finance lease, which tends to cost less because of the longer term and lower residual risk. Typically, this is a full-payout, noncancelable agreement in which the lessee is responsible for maintenance, taxes and insurance. However, the equipment may be considered a depreciable asset and be listed as a liability on your balance sheet.

A fair market value lease, sometimes called a true lease, has the most options and is usually recommended for SOHOs, which sometimes put up a small security deposit and make relatively low monthly payments. At the end of the term, the lessee has the option of extending the lease, returning the equipment or buying it at fair market value. Like most of the other leases mentioned here, this lease qualifies under IRS regulations as allowing the lessor to claim ownership and you (the lessee) to claim rental payments as tax deductions. Why? Because operating-lease payments are treated as a business expense, not a liability, and can be deducted immediately from operating income.

A $1 buyout lease is good if you're fairly certain you'll want to buy the equipment when your lease expires. While $1 makes you the owner, monthly payments are typically higher than with other leases. The terms of this type of lease may differ from state to state because of certain state sales tax laws that may view the lease as an installment sale; this can determine who pays the tax, the lessor or the lessee.

There are several other leasing plans that incorporate some or all of the above, including seasonal, step-payment and sales/leaseback plans, that can be tailored to your business's needs.

Some leases offer a bargain purchase option, allowing you to buy the equipment for a price determined at the start of the lease that is substantially lower than the expected fair market value at the end of the lease. A master lease is a contract whereby you lease currently needed assets and are later able to obtain other assets under the same basic terms and conditions without negotiating a new contract.

And the choices don't stop there. Leasing companies incorporate their own variations into the general types of leases noted above to attract businesses looking for the best deal. Advanta Corp.'s TechSmart program, for example, lets businesses upgrade equipment without terminating their leases. "TechSmart provides clients with the latest equipment every 18 months--halfway through a lease--which gives companies great flexibility to try new technologies without being tied into three years of financing," says Kohler.

Lease terms usually vary from six months to six years. Most, however, are for 36 months and can include periodic maintenance, insurance and discounts on parts such as toner. To determine which type of lease is best for your company, you and your accountant should consider how long you want to use the equipment, what you intend to do with it at the end of the lease, how your cash flow and tax situation will be affected, and what your company's present needs are as they relate to future growth. Some types of technology, such as state-of-the-art data processing systems, are updated very frequently, so lease agreements should contain clauses to cover constant upgrades if your business requires them.

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This article was originally published in the February 1998 print edition of Entrepreneur with the headline: To Lease Or Not To Lease?.

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