There are two types of leases, operating and capital leases, each with different accounting methods that can have a significant impact on taxes owed by the business. An operating lease is treated like renting, and lease payments are considered operational expenses. A capital lease is treated like a loan, and the asset is considered owned by the lessee.
The tax advantages of operating leases are especially significant for fixed assets such as lighting that are generally depreciated over a very long term (39 years), since the entire lease payment is tax deductible. Operating leases also make it possible for some businesses to claim an abandonment deduction for removing the old fixtures.
Because of the tax advantages,
the net cost of leasing an upgrade
can be less than if you paid cash upfront!
- Asset is considered owned by the lessor (i.e. Capital Leasing), so accounting is treated like a rental.
- Lease term is less than 75% of the estimated life of the equipment.
- The present value of lease payments is less than 90% of the equipment’s fair market value.
- No debt on the balance sheet. Payments are shown in Profit & Loss Statement, simplifying accounting and improving financial reporting.
- Accelerated Depreciation: The entire lease payment is considered an operating expense and is tax deductible, offsetting income dollar for dollar.
- Tax Abandonment: Take an additional deduction by “abandoning” old fixtures. This deduction can be quite substantial as it is based upon the purchase price of the new system.
- Provides flexibility and an improved Return on Investment (ROI) without capital budgeting restraints.
- Asset is considered owned by the lessee (i.e. business or building owner), so accounting is like a loan.
- Lease term equals at least 75% of the asset’s estimated life.
- The present value of the lease payments equals at least 90% of the total original cost of the equipment.
- Payments are shown as debt on the Balance Sheet. The leased equipment is considered a leased asset.
- Lessee claims only depreciation expense and interest expense. For lighting, depreciation is spread out over 15, 27.5, or 39 years.