Equipment Leasing: Is It Right for You?

Oct 1, 2001 12:00 PM, By Matthew Halverson, Associate Editor

For electrical contractors who want new equipment without the hassle of massive debt, leasing can be a viable financing option.

The thought of buying new equipment is enough to put any electrical contractor's acid reflux into high gear. Regardless of your net worth, plunking down $25,000 to $30,000 for a new truck, trailer, or genset is not something to look forward to, especially as the economy continues to soften and belts tighten. Factor in the additional expense of taxes on that new piece of equipment, and it's enough to make you want to roll the dice and see if that 20-year-old clunker can last just one more year. But before your inner High Life Man tells you to get out the duct tape, there is another option. Leasing new equipment can keep your operating line intact and save you a little money come tax season.

“If you're working with a quality leasing company, there's no reason not to lease,” says Duane Cox, president of Lease Associates, Sedgewick, Kan. “It's a wonderful tool for financing equipment for your business because you get to write it off.”

The word “lease” conjures the image of a low down payment, low monthly payments and the option to trade in the asset at the end of the term for a newer model — in other words, little commitment. However, in the case of large equipment, like trailers and gensets, leasing is an option that can save you money, not help you avoid a long-term commitment.

Give me ‘tax’ shelter.

For a small- to medium-sized business that uses the majority of its bank line for short-term financing needs like payroll and inventory, the relatively small amount of upfront capital necessary for a lease can make it an appealing option, according to Cox. More importantly, though, leasing allows you to expense monthly payments on your tax return.

“When they lease equipment, the lessee is, in essence, paying rent for the equipment, and that rent — in most cases — can be written off as an expense item on their tax return,” Cox says. “That's the main reason behind equipment leasing — they can expense the monthly payments.”

In a “true lease,” the lessee, or the individual leasing the equipment, can write off the monthly payments on the lease as business expenses on yearly tax returns, and the equipment can be purchased for a predetermined percentage of the fair market value at the end of the lease (often 10% of the original selling price). On the other hand, an “abandonment lease” cannot be expensed, but the lessee is eligible for a bargain purchase option at the end of the lease, in some cases as low as $1. Both leases have their financial benefits, but the particulars can be confusing.

“It is a little misleading, because a lot of people think any type of lease can be expensed, but that's not entirely true,” Cox says. “What we tell people in regards to a lease and how they apply it to their taxes is they should talk to their accountant.”

A riskier option, the terminal rental adjustment clause (TRAC) lease, can offer a lower interest rate over a 60-month term, but if the lessor cannot resell the equipment for a predetermined percentage of the original selling price once it is returned, the lessee must pay the difference. If the lessor resells the equipment for more than that price, however, it is obligated to pass the profit on to the lessee.

Don't let your past haunt you.

When considering a lease, it's important to remember that your business's credit history will play a large part in determining whether you're eligible for the lease. But the background checks don't stop there. If you operate a closely held business — one that is privately owned by one or two people — your personal credit history will be up for review, and it's just as important as that of your business. In fact, Cox says bad personal credit can kill a deal — even if you have flawless credit through your business.

However, exceptions can be made. Jule Kreyling, vice president and division manager of the Commercial Finance Group for CitiCapital, formerly American Equipment Leasing, Reading, Pa., says leasing companies are more likely to overlook a lessee's credit problems if the two sides have established a long-term, good-faith relationship.

“Even if their financial condition might not look as strong as it should, if you know that person, if you've dealt with them in the past, you're going to be more flexible,” he says. “There are cycles in the economy; [lessees] go through ups and downs that you've been through with them, so you understand. It's much more of an art than a science.”

Regardless of how long you've been dealing with a leasing company — whether it's 10 years or 10 minutes — Kreyling says the most important thing you can do if you have credit problems is be upfront about them. Lessors are much more willing to make exceptions if you confront your past and explain why your credit report doesn't look as strong as it should.

Buyer beware.

Although the advantages can make leasing seem like a win-win proposition, there are things to be careful about when negotiating the terms of your lease. The classic caveat of “Get it in writing” applies, but knowing what words to look for is even more important. Hidden fees, insurance binder fees, and penalties for failing to submit your updated financial reports can sneak up on you if you're not aware of them.

In particular, penalties for an early buyout of the lease can strip some of the luster from the image of leasing. In many cases, lease agreements will include a clause requiring the lessee to pay the remaining principal, plus interest and fees not yet accrued if he or she opts out of the lease early. In other words, if you have a 36-month lease but want out after 12 months, you will owe the total of your final 24 payments — not the remaining principal.

“The lessor has spent a lot of time and effort and money upfront, so they're not going to want to walk away with nothing,” Kreyling says. “It is something you have to be careful with. That's a risk of leasing, and you may be surprised at what [the cost of a buyout] is going to be.”

Another mistake too many people make, according to Cox, is shopping for a lease based strictly on interest rate, as opposed to the monthly payment.

“A bank may tell you your annual percentage rate on this item is 9%,” Cox says. “Well, that may sound good, but they've got so many hidden fees, like closing costs, origination fees, and document fees that don't factor into the APR.” By asking what your monthly payment will be, you can more accurately compare deals between one leasing company and the next — regardless of what interest rate they may quote.

Kreyling admits monthly payments may be a little higher with a national leasing company, but bigger companies have their advantages, too.

“Maybe we're a little higher-priced than someone else — that's definitely a benefit the local guy will have over us — but if you're giving good service, the customer will be willing to pay a little more for that,” he says.

Is leasing right for you?

Whether you deal with a big company or a small one, Cox still believes leasing is a finance option that can save contractors a considerable amount of money.

“Once they [lease] and see the benefits, then that's pretty much the only way they'll ever want to acquire equipment.”