Operating Lease or Capital Lease?

In recent years the practice of leasing equipment and vehicles, rather than purchasing them, has increased by leaps and bounds. There are a number of reasons why a business may consider leasing as an attractive alternative. All leases are NOT created equal and lease programs can vary significantly from one leasing company/lender to the next. In fact, some leasing companies may offer a variety of lease programs with terms designated to meet differing needs of the customers.

Most advertising involving leases focuses on two components of the lease - monthly payment and lease term. However, there are other important variables that you should consider when selecting a lease.

To avoid surprises about the total cost a lease transaction, you need to know about the cost of:

• Residual amounts
• Up front fees
• Fees at the end of the lease
• Restrictions on the use of the leased item

For an example of how these other costs can impact you, check out the comparison of two vehicle leases on our Truck Leasing Program Page.

Lease to use and return, or lease to own?

Lease transactions usually are classified by accountants as either Operating Leases or Capital Leases. From a practical standpoint, Operating Leases allow you to have use of an asset over a portion of its useful life without owning it. Operating Leases typically resemble renting; with short lease periods and low payments relative to the total value of the asset.

Capital Leases are essentially an alternative way to obtain financing for your operation's capital needs. Although you do not take title during the term of the lease, the payments and lease term are more similar to a purchase than to a rental agreement.

For accounting purposes, a lease is a financing transaction called a Capital Lease if it meets any one of four specified criteria; if not it is an Operating Lease. Capital Leases are treated as the acquisition of assets and the incurrence of obligations by the lessee. Operating Leases are treated as current operating expenses. You should consult with your accountant for advice on the proper accounting and tax treatment of different leases.

Which program is right for you?

With so many lease options, it is important that you check out all of the details and select the program that best meets your objectives. It is quite possible that a loan will be the least expensive method to finance the acquisition of your capital needs. The following is a guide to help you determine which product may be best for you.

Reasons to select a "pay for only what you use" lease.

• You do not have adequate cash flow to make the higher payments or the down payment required with traditional financing.
• You do not expect to exceed the annual mileage restrictions or other limits placed on your use of the leased asset.
• You only have a temporary need for the vehicle or item of equipment that you are leasing.
• You desire the possibility of deducting the lease payment from your taxable income rather than using a standard depreciation deduction. (With this type of lease, there may be minimal differences between the lease payment and the allowed depreciation amount.)
• You do not want to have anything at the end of the lease term - You plan to return the leased asset, pay any applicable penalties and fees and then purchase or lease another vehicle or item of equipment to replace the one you returned.

Reasons to select a capital lease.

• You may want to eventually own the asset, but you do not want to make the large down payment required with traditional financing.
• You are able to make somewhat higher payments during the term of the lease to lower the overall cost of the lease transaction.
• You plan to keep the vehicle or item of equipment after the lease term, or resell it for more than the residual cost.
• You desire the possibility of reducing your tax liability during the lease term by accelerating the capital expense. (Not all leases qualify for this accelerated deduction. Check with you tax advisor.)

Reasons to purchase outright with traditional financing.

• You desire to retain the asset after the loan is paid off and enjoy its use without having to make payments to a lender.
• You desire yield rates that are probably lower than those normally available with leasing.
• You are able to make a typical down payment and regular loan payments.
• You desire to use standard depreciation schedules and interest expense to manage your tax liability.