- What is a lease?
- What types of equipment qualifies for a lease?
- What type of purchase options are available?
- How do I get tax benefits from a lease?
- How long do I have to be in business?
- What considerations affect the lease-buy decision?
- Can leasing help “cash flow?”
- What is a sale-leaseback?
- What are the advantages of a sale-leaseback?
- Is there a down payment?
- Can payments be adapted to seasonal cash flow needs?
What is a lease?
A lease is a contract. By its terms, the “Lessor” (Leasing Company) gives the “Lessee” (The Customer) the exclusive right to use and possess its equipment for a specified period. In recent years, equipment leasing has become an accepted and economical source of financing. A lease can finance the acquisition of equipment or act as an additional source of working capital. In this respect, it acts as an alternative to traditional debt financing. The lease contract may be a single transaction involving specific equipment, or it may be written as a “master” lease with a continuing arrangement, on specific equipment having separate schedules executed from time to time. In either case, the contract will require the lessee to make periodic payments (or “rentals”) to the lessor for the use of the leased equipment.
What types of equipment qualifies for a lease?
All new or used tangible property subject to depreciation used in a trade or business can be leased. Some examples are: cars, trucks, tractors and trailers, construction equipment, machine tools and industrial equipment, telecommunications systems and related equipment, computers and data processing equipment, furniture, fixtures, office equipment, medical equipment or convenience store equipment.
What type of purchase options are available?
There are basically three types of purchase options:
FAIR MARKET VALUE (True Lease): This purchase option is the most commonly used purchase option since it has the most tax advantages and options at the end of the lease. At lease end, the lessee has the option to continue to lease the equipment, return the equipment, or purchase the equipment at its fair market value.
10% PURCHASE OPTION: This option establishes a fixed purchase price at the end of the lease. The customer has the option to purchase the equipment for 10% of the original purchase price, continue to lease it, or upgrade the equipment.
$1.00 PURCHASE OPTION: This option is for those who want to have a nominal purchase option at the end of the lease term. They simply pay $1.00 plus a small charge for the processing, primarily if any title transfers are required. The lessee is typically treated as the owner of the equipment for tax purposes. As with any financial decision, we suggest you consult your accountant when determining what type lease structure is best for your particular situation.
How do I get tax benefits from a lease?
In a Capital Lease, the Lessee is treated as the owner of the equipment for tax purposes. Therefore, it can claim depreciation deductions on its tax return. On the other hand, in a Operating Lease, the Lessee is not the owner of the equipment for tax purposes. It cannot claim depreciation deductions on its tax return. Nevertheless, because the Lessor is entitled to the tax benefits on the equipment, the Lessee will benefit from lower rental payments, often below market rates. In addition, the lessee normally would receive deductions for the full amount of rental payments on its tax books.
How long do I have to be in business?
In most cases our programs require a minimum of two years in business. However, exceptions can be made based on the credit strength of the company and/or its owners. Southlake Capital also has a program for businesses that have been established for six months.
What considerations affect the lease-buy decision?
Your plans for the equipment to be acquired will affect your decision to lease or buy: How long do you plan on needing the equipment? What is the expected life of the equipment? Will new technology cause the asset to become obsolete? How will inflation affect its market value, particularly if you have to replace it? What is the value of cash savings from leasing to your company? Is your company now, or potentially, an AMT taxpayer? Is the expected value of the equipment at lease maturity offset by benefits of lower rentals during the lease term and the avoidance of minimum tax?
Can leasing help “cash flow?”
“Cash flow” is the normal flow of cash into and out of your business. Increasing cash flow may simply mean reducing payments to be made by your business. Often, leasing companies assume that equipment will have a residual resale value at the end of the lease and reduce the rental payments accordingly. This too produces a real cash savings. Finally, a Operating Lease can help an AMT taxpayer avoid additional minimum taxes, which would otherwise be due if the taxpayer owned the equipment. MACRS depreciation creates tax preferences but lease payments or rentals do not. This avoidance of minimum tax liability may be a real current cash savings, which is especially important because all taxpayers must pay their estimated minimum tax liability to the IRS on a quarterly basis.
What is a sale-leaseback?
A sale-lease back is an arrangement whereby the owner of equipment agrees to sell that equipment and immediately lease it back. Prior to the sale-leaseback, this equipment may be subject to a security interest of another party. In that case, the secured lender is usually paid off at the time of the sale.
What are the advantages of a sale-leaseback?
If the purchase of your equipment has already been financed, a sale-leaseback can allow you to refinance and can also provide another source for additional working capital plus the use and recognition of significant “hidden equity” in depreciated assets. Additionally, a sale-leaseback can help the lessee avoid liability for minimum tax. At the time a company purchased the equipment, it may not have realized that it was going to be a minimum taxpayer and that ownership of equipment would increase its minimum tax liability. These purchasers can correct this situation by selling the equipment to the lessor and leasing it back. Operating leasing, unlike ownership, does not create tax preference items for minimum tax purposes. A sale-leaseback, therefore, would eliminate any ongoing tax preference items related to the leased equipment.
Is there a down payment?
Leasing is generally considered 100% financing, with the leasing company paying the entire purchase price of the asset and leasing it to the lessee with no down payment. Operating leases requires the lessor to pay the full purchase price without any participation by lessee. Leases with relatively high risks for the lessor may require additional security. Additional security could take the form of advance rentals, a pledge of assets or security deposit.
Can payments be adapted to seasonal cash flow needs?
Yes. Some industries experience predictable irregular cash flows and/or seasonal slowdowns due to weather conditions, market conditions or a variety of other reasons. The impact of weather on the construction industry is just one example. For such businesses, leases may be arrange with payment due at irregular time, such as monthly from April to November only, in conjunction with the productive use of equipment.