June 2008 Edition

machine tool financing

Conserve working capital

Tax benefits of leasing equipment may be overlooked

With recession on the horizon — if not already here — business owners are stepping up efforts to maintain profits during the current bumpy economic storm. Those who have been through economic downturns previously know that maintaining cash flow and competitiveness remain their highest priorities.

Tough economic times may require businesses to make difficult choices between maintaining adequate capacity and cutting costs. One way to accomplish both goals is to make sure the business is making use of the most efficient, up-to-date equipment.

Additionally, leasing may provide a way of financing new equipment that allows the business to conserve working capital and minimize payments. Leasing, rather than buying equipment, is one way to accomplish these goals because leases typically have lower payments and require no down payment.

Lease payments are deductible in total as business expenses under the Internal Revenue Code of 1986. Purchased equipment is deducted through depreciation, and if financed, the interest portion of the loan repayments is also deductible.

If equipment is kept in service through the entire lease contract and/or its useful tax life, the entire cost of the equipment will be deductible. Leasing often accelerates the tax deduction because the entire monthly payment is deductible as paid.

In addition to tax and cash flow benefits, leasing has proven to be a smart way to keep equipment from falling into obsolescence. With the ever-accelerating changes in technology, growing numbers of businesses are in a constant race to keep their equipment up-to-date.

Leasing also can have the advantage of matching the tax deduction with the expense reported on the company’s financial statements.

One type of lease, a conditional sale, is treated like a loan for tax purposes. Specifically, a conditional sale lease can take advantage of federal tax code Section 179 for expensing up to $250,000 of the equipment’s cost, if the equipment is installed in 2008. This limit is reduced by the amount by which the cost of Section 179 property placed in service in the tax year exceeds $800,000.

Mixing the use of true leases and conditional sales leases can help a business avoid exceeding the $800,000 cap because leased equipment does not qualify for Section 179.

Due to the passage of the Economic Incentive Act of 2008, the Section 179 limit is double what it was originally authorized to be for 2008. This doubling of the limit may prove extremely beneficial to business owners.

Businesses may also be able to take an additional first-year special depreciation allowance for new equipment ordered and placed in service during 2008. This allowance is an additional deduction of 50 percent of the property’s depreciable basis after any Section 179 deduction and before figuring a regular depreciation deduction.

With a true lease, the lessor, such as a bank or leasing company, is able to use the bonus depreciation rather than the lessee. Since the lessor receives the direct benefit of an accelerated depreciation write off, it can pass the benefit of this savings along to the lessee in the form of a lower lease payment.

Quite often the lessor is in a better position to benefit from the bonus depreciation than the lessee. Also, as noted above, leasing the majority of its equipment may allow a business to preserve the maximum Section 179 deduction by preventing purchases from exceeding the $800,000 limit.

Before making any decision on how taxes may influence a decision to buy or lease equipment, business owners should talk with their tax consultant.

In addition to tax and cash flow benefits, leasing has proven to be a smart way to keep equipment from falling into obsolescence. With the ever-accelerating changes in technology, growing numbers of businesses are in a constant race to keep their equipment up-to-date.

Once a lease expires, a company can lease new, more cutting-edge equipment, tools, and machinery. Not only does this go a long way toward competing in terms of product and service, but companies with the newest in technology can also be more competitive in recruiting talent.

Wise business owners can be successful in challenging times. The secret to their success will depend upon a willingness to talk to their financial and tax advisors, and their ability to remain flexible when adding equipment to expand their business.

Huntington National Bank, Machine Tool Finance Group

What do you think?
Will the information in this article increase efficiency or save time, money, or effort? Let us know by e-mail from our website at www.ToolingandProduction.com or e-mail the editor at dseeds@nelsonpub.com.