Many owners understand the basic differences between leasing and buying, but overlook the specific business factors that must be considered before pulling the trigger.
The two common ways to finance a new business vehicle are buying and leasing. Neither method is inherently smarter or better—for some, leasing makes more sense, and for others, buying is the way to go.The key to making the right decision is to recognize and properly weigh the advantages and disadvantages of each option and how those pros and cons apply to your business.
How many times have you wrestled with the buy-versus-lease decision? Turns out there’s no one-size-fits-all answer; the decision about how to finance a business vehicle must be made case-by-case based on the particular financial circumstances involved.
Here’s how to make a sound decision about business vehicles for your own small business.
Factor 1: What you get for your money
Buy: Buying brings full ownership without restrictions on how the vehicle can be used and how far it can be driven.
Lease: Leasing gets you the right to use the vehicle over a fixed term—typically three to five years–subject to restrictions. When you lease, you pay only the portion of the vehicle’s decline in value that’s expected to accrue during the life of the lease.
Weighing the options: The above is the conventional wisdom. Recognize that leasing can result in ownership and that you may be able to exercise the buyout at the end of the lease for less money than you’d have spent to buy the vehicle.
ABC Trucks “sells” identical pickup trucks retailing for $30,000 to different customers:
Wanda buys one of the trucks for $30,000.
Lee leases the other for four years with an option to purchase for $9,000 at lease end.
ABC believes the truck’s fair market value will be $13,000 at the end of the lease. So ABC bases lease payments on $17,000 ($30,000 – $17,000). It turns out that the truck is actually worth $17,000 at lease end. Lee exercises the option.
Wanda paid $30,000 to buy the truck.
Lee paid $26,000 ($17,000 lease payments + $9,000 option) to acquire the vehicle.
Factor 2: What you pay up-front
Buy: When buying a vehicle, you must come up with a chunk of up-front cash, including a down payment (or full cash price) and:
- Sales and other taxes
- Other government or lender charges
- Optional insurance and services
- First monthly payment (if you’re financing the vehicle)
Lease: You pay less cash up-front when you lease. Up-front leasing costs typically cover:
- Capitalized cost reductions
- Other government or lessor charges
- Optional insurance and services
- First monthly payment
- Refundable security deposit
Weighing the options: Leasing is better if you have cash flow problems or better uses for your cash (e.g., the opportunity to use the cash for investments with a higher return). Of course, the cash trade-off isn’t always black and white. Thus, you might benefit by simply making a larger down payment on the lease to get a lower monthly lease payment.
Factor 3: What you pay per month
Buy: Monthly payments are higher on purchases because you pay the entire purchase price of the vehicle plus sales taxes, interest, other finance charges, license fees, personal property and maybe other taxes.
Lease: Monthly lease payments are lower because you pay only for the depreciation of the vehicle over the lease term plus rent charges and taxes.
Weighing the options: Because lease payments are lower than monthly purchase payments, you can afford a more expensive vehicle by leasing it. In other words, the same $400 per month you’d have to pay to purchase a Chevy might be enough to lease a Cadillac.
Factor 4: What you pay in non-tax depreciation
Non-tax depreciation (i.e., erosion of the vehicle’s fair market value during the time it’s used) is a cost of both buying and leasing. Further, the non-tax depreciation makes its way into your taxes in the form of deductions and/or loss on sale (if you own the vehicle).
Buy: The decline in value from the time of purchase to the time of sale is a cost that adds or subtracts from your pocketbook. But you might overlook non-tax depreciation and residual value when you buy a vehicle.
Lease: A lease is essentially a bet between you and the lessor on non-tax depreciation and its effect on the purchase price option at the end of the lease. In this “closed-end lease,” you know up front how much you can buy the vehicle for at the end of the lease (as opposed to an “open-ended lease,” where you don’t know the actual residual value until you turn in the vehicle).
Weighing the options: Recognize that you’re making a residual value bet either way. When you lease, you bet against the lessor. When you buy, you bet against yourself. You take the risk that the vehicle’s value will depreciate more than expected and leaves you owing more on the loan than the vehicle is worth. Leases don’t leave you “upside down,” because the lessor assumes the risk of unexpected depreciation.
Factor 5: The tax deductions you get
Whether you buy or lease, you’re generally allowed to deduct the business costs of the vehicle using either IRS standard mileage rate for the tax year or their actual expenses.
Caveat: Remember that you can’t use the IRS standard mileage rates–you must rely on actual costs if your corporation owns or leases the vehicle.
The question of whether to lease or buy business vehicles has bedeviled small-business owners (and their advisors) for years. Neither method is inherently superior to the other. To make the smart decision, you need to consider your particular circumstances, including cash flow, taxes and psychological needs.
Your financial advisor can often walk you through the pros and cons of each approach to help you make a confident decision without buyer’s (or leaser’s) remorse. In Part 2 of this article, we’ll look at what happens when you get rid of the vehicle, what you pay for excess mileage and wear, how much flexibility you need, and other personal considerations.
Need help with business decisions such as these? Contact Us.
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