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Equipment Loan vs Lease: How to Think About It
A loan buys you the equipment. A true lease rents it. The labels on the paperwork do not always decide which one the IRS sees.
Loan: you own it
With a loan you hold title to the equipment (the lender usually keeps a claim on it until you pay). Your payments cover principal and interest. You keep the equipment after the last payment, and you are exposed to its resale value.
Lease: you rent it
With a true lease you pay for the use of the equipment over a term. At the end you usually return it, renew or buy it, depending on the contract. The lessor takes the risk that it is worth less than expected, which is part of why the monthly payment can be lower.
How the IRS tells a lease from a purchase
The IRS says you must first decide whether the agreement is a lease or a conditional sales contract for federal tax purposes. If it is a lease, you may deduct the payments as rent. If it is a conditional sales contract, you are treated as the purchaser and generally recover the cost through depreciation. The IRS lists conditions that point to a conditional sales contract, including:
- Part of each payment builds equity you will receive in the property.
- You get title after a stated amount of "rental" payments.
- You can buy the property at a nominal price, or for a small amount compared with the total you pay.
- You pay much more than the current fair rental value.
- Part of the payments is designated as interest, or is easy to recognize as interest.
No single test always decides it. A $1 buyout lease, for example, looks like a purchase on several of these factors.
What this means for Section 179
Section 179 applies to property you purchase. If your agreement is treated as a purchase, the deduction may be available. If it is a true lease, you generally deduct the payments instead. Which is better depends on your income, your plans for the equipment and your tax advisor's view. Use the loan vs lease calculator to see both paths with your own numbers.