What You Need to Know about Equipment Leases
Equipment leasing is an alternative to purchasing new equipment. Amid volatile interest rates and inflated equipment costs, more businesses are turning to leases as they look for ways to preserve cash while acquiring the equipment they need to operate. Equipment leases typically enable businesses to avoid the need to make a large down payment, which is usually required for an equipment purchase, but they may include a purchase option at the end of the lease period.
Leasing may be a smart choice in today’s economy: it may reduce monthly ownership costs, provide flexibility to upgrade critical equipment, and offer tax benefits. Deciding whether a business is better off leasing or buying an asset will depend on the lease terms, which should be drafted and reviewed by a business attorney.
What Is Equipment Leasing?
Equipment leasing is different from an equipment loan. With a lease, a business pays to use equipment over a specific period under a lease agreement. A loan, on the other hand, enables a business to purchase the equipment outright.
Compared to traditional purchase financing, which may require a down payment of up to 25 percent or more, leases often require no down payment and may cover up-front costs such as installation and training. The following equipment is commonly leased:
Agricultural equipment
Aircraft
Business, retail, and office equipment
Construction and off-road equipment
IT equipment
Manufacturing and industrial machinery
Medical technology and equipment
Mining machinery
Trucks and transportation equipment
Vessels and containers
The Benefits of Leasing
Leasing equipment can provide the following benefits as compared to purchasing equipment:
Protection from equipment obsolescence. Leasing can ensure that a business has cutting-edge equipment that incorporates the latest design and technology and provides a competitive advantage.
Tax breaks. Depending on the type of lease, businesses may be able to fully deduct equipment lease payments to obtain potentially significant tax savings. Alternatively, they may be able to deduct depreciation.
Cash flow optimization. Leasing allows a company to shift from a capital expenditure to an operating expense model that eliminates substantial up-front investment and preserves the amount of available cash.
Equipment leasing offers the following additional benefits:
Flexible lease terms
Lower monthly ownership costs
Fixed, predictable payments
Inflation impact management
Better ability to upgrade critical assets
Maintaining business flexibility by leasing equipment is particularly important in the current business environment, which has recently been characterized by many wild cards.
Types of Equipment Leases and Lease Terms
A lease is a form of rental agreement in which the owner (the lessor) of the equipment comes to terms with a company or individual (the lessee) about the use of the equipment for a set period of time in exchange for monthly payments.
There are two main types of equipment leases: capital leases (i.e., finance leases) and operating leases (or true leases).
Capital Leases
Capital leases are used to effectively finance asset purchases and give the lessee the option to purchase an asset at the end of the agreement for a predetermined price.
Capital leases are typically treated as a sale for accounting and tax purposes, with the lessee’s payments establishing equity in the asset. During the lease term, the lessee has the rights associated with ownership. For tax purposes, this means that the lessee may be able to use the equipment’s depreciation as a deduction. However, the lessee is also usually responsible for equipment maintenance.
Capital leases may make sense when a company intends to use a piece of equipment for a long time and plans to take ownership of it at the end of the lease.
Operating Leases
Operating leases are more like a true rental agreement. The lessee uses the asset without actually owning it, although the lease agreement may contain purchase options at the end of the lease term.
Operating lease payments do not establish equity in the asset, but they also are not recorded as debt on a company’s books. The tax advantage of an operating lease is that monthly payments may be deductible, similar to a rented office space.
Operating leases can be a good option for businesses that need to use the equipment for a shorter period and plan to replace it at the end of the lease or are uncertain about their long-term needs.
Lease Terms
The type of lease affects not only a business’s financial statements, accounting, and taxation but also the contractual obligations that are placed on the lessee, such as the requirement to insure the leased equipment, pay for maintenance and repairs, and shipping charges.
The following are key terms to look out for in an equipment lease:
Duration. Specifies how long the lease is in effect and may include renewal options.
Rental rate. Identifies the amount of rent due and when payments must be made.
Early termination. Describes when the lease can be amended or ended. These provisions can be wide-ranging and detailed and, from the lessee’s perspective, need to be negotiated with an eye toward circumstances under which the equipment would become obsolete or no longer useful to the business.
Insurance. Identifies whether the lessor or lessee is required to insure the equipment and who is entitled to an insurance settlement if the equipment is damaged, lost, or stolen.
Maintenance. Stipulates which party is required to maintain the equipment.
Master lease. Permits an addendum to the original agreement providing the terms for the rental of additional equipment. This may be advantageous because leasing more than one piece of equipment from the same lessor can help the lessee negotiate and save money.
Modifications and improvements. Specifies whether the lessee can improve or modify the equipment to better suit their needs or to comply with federal or state regulations.
Purchase option. Identifies the lessee’s right (or obligation) to purchase the equipment. It should identify a purchase option price or price range and how and when the purchase option can be exercised.
Stipulated loss value. Establishes a formula for determining how much the lessee may owe for equipment that is damaged, lost, or stolen due to a casualty loss.
Substitution. Provides terms related to updating or replacing the equipment during the lease period. This may be a crucial aspect of a lease for high-tech equipment such as computers and communication devices prone to rapid obsolescence.
Termination costs. Specifies who must pay costs like dismantling, insuring, and shipping the equipment at the conclusion of the lease term.
Transfers. Addresses whether the lessor or lessee has the right to transfer their interest in the lease (e.g., a sublease), and if so, under what circumstances.
Talk to a Business Attorney about Equipment Leasing
Our business attorneys can draft an equipment lease with favorable terms or represent you if a dispute arises between you and the other party to a lease. Look before you lease: contact us today to schedule a meeting with one of our business attorneys.
