Equipment Leasing ― The Ultimate Guide for Small Business Owners

Equipment leasing allows businesses to acquire equipment without purchasing it. Leasing agreements can be obtained from some of the same sources as equipment loans: banks, dealerships, equipment manufacturers, and even nontraditional financing companies. Lease payments are often significantly lower than loan payments, although balloon payments may be due at the end of the lease.

Ohio Business Funding offers equipment leasing for new and used heavy equipment. Requirements include a credit score of at least 600 and at least 5% down. Borrowers who qualify can secure financing of up to $500,000.

How Equipment Leasing Works

Leasing requires businesses to make regular payments in exchange for the use of equipment. It is ideal for companies that need equipment that may have to be upgraded regularly or equipment that would be too expensive to purchase outright. Depending on the type of lease, the borrower may gain ownership of the equipment, or there may be no transfer of ownership.

Equipment leases usually fall into one of two categories:

• Capital lease: The business receives all benefits and drawbacks of ownership. The most common form of lease, a capital lease, is best for expensive equipment that a business intends to keep long-term. With a bargain purchase agreement, the business gains ownership at the end of the lease.



• Operating lease: The business doesn’t receive benefits and drawbacks of ownership with an operating lease ― it is simply a rental. Ownership doesn’t transfer upon the completion of the lease, which is ideal for items that need frequent replacement due to short useful life.

Equipment Lease Qualifications, Rates & Terms

Equipment lease qualifications are often similar to equipment loan qualifications. The equipment is used as the collateral for the lease, meaning rates are lower than using an unsecured line of credit to purchase equipment.

5 Factors That Determine Qualification

As is the case with equipment financing, several factors determine the likelihood of approval when obtaining an equipment lease. Those factors include:

1. Credit score
2. Business history, including time in business and annual revenue
3. Type and size of the lease
4. Length of the lease
5. How well the equipment keeps its value as it depreciates

Businesses will need to provide at least one year’s worth of income tax returns; however, two or three may be required by some lenders. Interest rates will be better for well-qualified borrowers, with some lenders offering rates as low as 6% for equipment leases.

Equipment Lease Tax & Accounting Treatment

As with equipment purchases, equipment leases can be deducted from your business taxes in certain circumstances as you can claim the depreciation on the equipment. In some cases, the entire amount of depreciation can be claimed in year one instead of graduated depreciation during the life of the lease. As always, consult your tax professional for guidance on the tax benefits of leasing.

We recommend speaking with a certified public accountant (CPA) or tax professional about these options before you decide.

$1 Buyout Lease

A $1 buyout lease is similar to an equipment loan. Borrowers make payments to rent the equipment, and at the end of the lease, have the option to purchase the equipment for $1. This makes the payment size the highest of any of the lease types. The asset leased and liability will show up on your balance sheet.

Interest rates will be the lowest on this type of lease. Use this type when you want to own the equipment at the end of the lease.

$1 Buyout Lease Tax and Accounting Treatment

Here are some potential tax and balance sheet implications of the $1 buyout lease. Consult your tax professional for more information.

• Depreciation: Under Section 179, equipment value can be deducted up to $1 million
• Payment deduction: Interest payments can be deducted as interest expense
• Balance sheet: The equipment will be listed as an asset and a liability

Who it’s best for: This is best for borrowers who want to purchase the equipment but want to spread out the cost of the equipment into equal payments instead of having a larger lump sum at the end of their term.

10% Option Lease

Like the $1 buyout lease, a 10% option lease allows the borrower to make payments and have the option to purchase the equipment for 10% of its initial value at the end of the lease. For example, a $50,000 piece of farm equipment would have a final payment of $5,000 at the end of the lease to transfer ownership. The monthly payment would be lower on the 10% option lease than the $1 buyout lease, with the larger balloon payment held at the end of the lease.

While the 10% option lease can be used for equipment that a borrower would want to gain ownership of at the end of the lease, the borrower would also have the option to walk away at the end of the lease, foregoing the 10% payment and returning the leased equipment.

10% Option Lease Tax and Accounting Treatment

Here are some potential tax and balance sheet implications of the 10% option lease. Consult your tax professional for more information:

• Depreciation: Under Section 179, equipment value can be deducted up to $1 million
• Payment deduction: Interest payments can be deducted as interest expense
• Balance sheet: The equipment will be listed as an asset and a liability

Who it’s best for: This type of loan is best for businesses that aren’t sure whether they want to purchase the equipment at the end of the term.

Fair Market Value Lease

A fair market value (FMV) lease allows the borrower to make payments and use the equipment throughout the lease and allows the borrower to purchase the equipment at the end of the lease for fair market value. Borrowers can also choose to renew the lease or return the equipment at the conclusion of the lease.

In contrast to the first two types of leases discussed here, the borrower does not get the benefits or drawbacks of ownership. It also means that only monthly payments can be deducted from the lessee’s taxes. These leases are the hardest to qualify for, meaning a strong credit score and high annual revenue are needed and, usually, the equipment leased must be a high-value item.

This is not an ideal lease type if a borrower plans to purchase the equipment at the end of the lease. Monthly payments are lower, but the interest rate will often be higher than the $1 buyout or the 10% option because the lessor has a higher risk due to the likelihood of having to find another renter for the equipment.

FMV Lease Tax and Accounting Treatment

Here are some potential tax and balance sheet implications of the FMV lease. Consult your tax professional for more information:

• Depreciation: Not available
• Payment deduction: Only full payments can be deducted as operating expenses
• Balance sheet: The equipment must be listed as an asset and a liability

Who it’s best for: An FMV lease is best for businesses acquiring equipment that they know they will replace at the end of the term or equipment that has a very short shelf life.

10% Purchase Upon Termination Lease

The 10% purchase upon termination (PUT) lease is the same as the 10% option lease with one significant difference: the borrower does not have the option to walk away. This decreases the risk for the lessor because the lessee must purchase the equipment at the end of the lease. Also, this makes it easier for borrowers to qualify for 10% PUT if they have bad credit.

All other information regarding payments and tax implications from the 10% option lease apply here.

10% PUT Lease Tax and Accounting Treatment

Here are some potential tax and balance sheet implications of the 10% PUT lease. Consult your tax professional for more information:

• Depreciation: Under Section 179, equipment value can be deducted up to $1 million
• Payment deduction: Interest payments can be deducted as interest expense
• Balance sheet: The equipment will be listed as an asset and a liability

Who it’s best for: This type of lease is best for businesses that want to purchase the equipment at the end of the term but need a lower payment than the $1 buyout or 10% option leases would provide.

Terminal Rental Adjustment Clause Lease

A terminal rental adjustment clause (TRAC) lease is typically used for semi-trucks and other vehicles. It can be either a capital or operating lease. This lease gives the lessee flexibility to set up a higher balloon payment at the end of the lease, which is why it is ideal for truck or vehicle loans. It has lower monthly payments throughout the lease because of the higher balloon at the end.

Borrowers should have strong credit profiles because of the increased risk to the lessee with the high balloon at the end. This type of lease is used when the lessee doesn’t want to own the asset at the end of the lease, usually because they want to upgrade to a newer-model vehicle.

TRAC Lease Tax and Accounting Treatment

Here are some potential tax and balance sheet implications of the TRAC lease. Consult your tax professional for more information:

• Depreciation: If it is a capital lease, it can be depreciated. Operating leases cannot be depreciated.
• Payment deduction: Full payments are deductible if it is an operating lease. Otherwise, interest paid can be deducted in a capital lease.
• Balance sheet: This will be listed as an asset and a liability in most cases. Check with your tax professional.

Who it’s best for: A TRAC lease is only for vehicle purchases or leases and is right for those who need more flexibility in deciding how much to pay at the end of the term if they want to purchase the vehicle.

When to Use an Equipment Loan Instead

Many equipment leases are very similar to equipment loans. One of the biggest differences is that equipment loans always result in a transfer of ownership at the end of the loan. Also, loans can be paid off early with no prepayment penalty. For businesses looking to upgrade equipment at the end of a repayment period, leases give the borrower more flexibility. In some cases, lessees can walk away from a balloon payment at the end of a lease, making for lower monthly payments than loans with no ownership requirement at the end.

Businesses should consider the following when deciding between a lease or a loan:

1. Are lower payments necessary? Leases often offer lower payments.
2. Is ownership necessary or desired at the end of payments? This is guaranteed with loans, although certain types of leases allow for this as well.
3. Will the borrower look to upgrade at the end of payments? Leases make more sense for businesses looking to upgrade because, with many leases, they will be walking away from balloon payments.



Bottom Line

Many factors go into the decision to get an equipment lease ― as opposed to an equipment loan ― and the type of equipment lease. Consult a tax professional on all large capital expenditures to determine the best course of action for the business. In many cases, leases make sense, especially if the business intends to upgrade equipment at the end of the lease or if it needs lower payments provided by leases with balloon payments at the end. If a business wishes to lease equipment to gain ownership at the end, a $1 buyout lease or a 10% PUT lease makes the most sense.