Purchase vs. Lease

[Finance Guy]

Hi John C,

A 30k residual on a 100k lease would be 30%; I have never seen a residual that high. If for some extra ordinary circumstance someone was in that position my advice would be to walk away from the machine. Being that the machine is only worth 20% of its original value after such a short time I would turn it in and get a different machine. Being that it is a true lease you have the option of returning the machine at the end of the term with no penalties. Now, if you really liked the machine you could buy it for the stated residual and own it but that would mean paying 30k for a machine that is only worth 20k... Not such a great idea. Also, if you had a true lease that had "Fair Market Value" at the end of term you could buy it for the 20k.

Did that help?

Todd

 

[Orchard Ex]

How does the lease expense compare with depreciation expense tax wise?

 

[ror76a]

O.K. lets see if I have this right:

Purchase Price $150,000
Total Months 48
Monthly Payment $3,000
Yearly Payment $36,000
Total Payments $144,000
Residual $15,000
Total Paid $159,000
Lease Preimium $9,000
Tax write off % 33%
Write off/yr $11,880
Total Write off $47,520
Total paid-write off $111,480
Total savings $38,520

I made a spreadsheet to do the math, but I cant attach it apparently. The green are values that I made up, don't know how realistic they would be.
Now for my questions. How do you take the 33% (for that matter how do you determine the %) of the lease payments that you can take off of your taxes? Does used equipment qualify for the write off? Can you lease used equipment? How is the residual determined (I used 10% of the purchase price), but if it was market value (probaly closer to 1/2 of purchase price) you may not have any savings??

Thats enough finance for me for tonight, :dizzy time for some :drinkup

 

[John C.]

Finance Guy,
Are you saying the lessor is responsible for the difference between market value and residual at the end of the lease. Is this what is called an open end provision? I've seen car leases that were closed end where the lessee had to pay the difference.

Also ror76a has a good question. Who and how are the residual and the percentages figured. I was also told that the lease payments were one for one against the bottom line as long as they were a true lease.

Thanks for the info!

 

[Finance Guy]

How does the lease expense compare with depreciation expense tax wise?

There are a couple ways to work a lease...

1) Accelerate the depreciation 100% the first year and call it good.
2) Write off the entire payment, year to year for the term as an operating expense. A lease is considered a rental to the IRS and can be completely written off

FG

 

[Finance Guy]

ror76a... You have some good information there. When you get to this point it is best to consult your accountant (preferably one that understands a lease) as I do not want to mis-inform you on percentages. I say this because the % is based on your tax bracket and I do not have all the necessary information to quote you.

Keep in mind that a lease is considered an operating expense and can completely written off.

Yes, used equipment can be leased, I do it everyday.

I never offer more than a 10% residual. Residuals are determined by the underwriting bank, most use either a $1.00 or 10%.
Fair market value residual is used as well but I rarely see them, these usually range between 15%-25%.

 

[Finance Guy]

Finance Guy,
Are you saying the lessor is responsible for the difference between market value and residual at the end of the lease. Is this what is called an open end provision? I've seen car leases that were closed end where the lessee had to pay the difference.

Also ror76a has a good question. Who and how are the residual and the percentages figured. I was also told that the lease payments were one for one against the bottom line as long as they were a true lease.

Thanks for the info!

You are combining two scenarios. You would either have a fair market value residual lease and the option would be for you to purchase the equipment for its fair market value. Banks would typically get comps from Machinery Trader and some vendors they work with. Keep in mind that a bank will usually not offer an FMV option if the equipment will have such a low value at the end of the term. You can also return the equipment.

The second scenario is the 10% residual option. You would simply have the opportunity to buy the equipment for 10% of the price when the lease was originated. I like to cap residuals at 10%.

Lease payments are one to one against the bottom line on a true lease.

 

[tuney443]

Something that has not been discussed which to a small owner-operator like myself is important is the fact that on a lease you are not allowed to customize or alter your rig because basically,simply put you ,don't own it.There are so many protective clauses in your contract,it would make a Philadelphia lawyer wince.I have never heard of any small owner happy with a lease,whether it's iron,a car,truck--the lending institution always comes out the winner---more so when you get penalized for going over your allowable hours/miles.

 

[Finance Guy]

Something that has not been discussed which to a small owner-operator like myself is important is the fact that on a lease you are not allowed to customize or alter your rig because basically,simply put you ,don't own it.There are so many protective clauses in your contract,it would make a Philadelphia lawyer wince.I have never heard of any small owner happy with a lease,whether it's iron,a car,truck--the lending institution always comes out the winner---more so when you get penalized for going over your allowable hours/miles.

tuney443... I finance small businesses everyday and, respectfully, I have no idea what you are talking about.

FG

 

[Finance Person]

Something that has not been discussed which to a small owner-operator like myself is important is the fact that on a lease you are not allowed to customize or alter your rig because basically,simply put you ,don't own it.There are so many protective clauses in your contract,it would make a Philadelphia lawyer wince.I have never heard of any small owner happy with a lease,whether it's iron,a car,truck--the lending institution always comes out the winner---more so when you get penalized for going over your allowable hours/miles.

tuney443- Most leases give you an option to upgrade. Of course you don't fully own the equipment yet since it’s a lease to own but I have never heard of lease from a lease finance company with miles and hours restrictions. Most of those restrictions are mainly done with penske and hertz type of leasing companies. With those guys you are restricted to their equipment and maintenance plan. By going through a regular equipment lease company you can pick and choose your equipment from a vendor or private party and it can new or used.

 

[tuney443]

I will bet you dollars to doughnuts that an average lease contract is at least twice as long as a simple loan agreement.And with all the covenants,restrictions,and the like,I personally would never enter into a lease.For some big businesses,it might be right,but not for an owner operator IMHO.

 

[PSDF350]

I will bet you dollars to doughnuts that an average lease contract is at least twice as long as a simple loan agreement.And with all the covenants,restrictions,and the like,I personally would never enter into a lease.For some big businesses,it might be right,but not for an owner operator IMHO.

Lenght isn't so much the problem> It is that you do pay more interest, but with a lease you can claim payments istead of deductable. So I think with equipment or cars/trucks that are being replaced every few years the tax benifit makes a lease more attractive. The downside of a lease is that if you lease to own (like I did anyway) you are going to pay every single dollar of that 3+- year lease. No paying off early for whats left on the loan. You want to get rid of that piece of equipment because it's not what you..... So you want to get rid of it and get something else/or not, you have to pay how many other payments you have left plus the dollar or what have you for buy out.

 

[Steve Frazier]

I'm not sure you are talking about the same kind of lease Tuney. I leased my second truck, just the cab and chassis. I paid cash for the dump body and installed a plow on it. I cleared this with the leasing company before I attempted any of this, and was told I could do anything with the truck I wished to make it work better for me.

There was no down payment, I bought the dump body with what I'd have put down and leased the full amount of the chassis. My buy-out was just over $1000 at the end of 4 or 5 years, I don't remember the term. The full payment came off as a tax deduction, not just the interest, and it didn't count as an outstanding loan on my credit rating. This was shortly after I started my business and I had other equipment to purchase as well. It worked out well for me in the situation I was in as a small business,

 

[JDOFMEMI]

A lease has many benefits, as Steve said above. The one major reason I will prefer not to lease is that you have to pay the full term of the lease if you decide to sell, maybe because the market chaanged, and you need to sell one piece to buy another. I have a friend in that situation now, and it just takes away some of your flexibility.
They are good for a lot of people though.
Just depends on your overall situation. One main advantage is its easier to qualify for a lease than conventional financing.

 

[tuney443]

A lease has many benefits, as Steve said above. The one major reason I will prefer not to lease is that you have to pay the full term of the lease if you decide to sell, maybe because the market chaanged, and you need to sell one piece to buy another. I have a friend in that situation now, and it just takes away some of your flexibility.
They are good for a lot of people though.
Just depends on your overall situation. One main advantage is its easier to qualify for a lease than conventional financing.

Umph--Sounds like what Eliot Spitzer just went through with his $4300 per hr. prostitute.---Yes, I hear what you guys are saying,but I'm not going to change my opinions any time soon. To each their own.

 

[Finance Guy]

It sounds to me like some people here have a good idea of the benefits of a lease.

It also sounds to me like some people have out of date financial information or information that has not been presented well.

Today there are leases called "Equipment Finance Agreements" that do not require you to go full term. They do not have early buyout penalties. If you have a 48 month term and want to sell it after 3 years go for it, you are NOT held liable for the remaining payments.

If anyone needs information give me a call.

Todd

 

[DirtyWorks]

Finance Guy, What are the penalties? If I enter into a four year lease and realise that I need a bigger machine can I "upgrade"? What happens if there is a major repair needed after the three year maufacturer warranty? Do I have to make payments for the last year and walk away from it? Do I have to keep it to a certain standard besides operational? Who determines "fair wear and tear" If it is a good and profitable machine, are you saying that I get to purchase it for 10% of the original value of equipment or 10% of total loan after 48 months? Is the downside that you have paid 90% of a piece of equipment only to start over again with a new fully warrented piece and the upside not having to worry about finding a qualified buyer who is looking for exactly that piece? How bad does it damage your credit if the machine has to go back due to failing/bad business? If it is "off balance" financing is there any equity on the part of my business if I decide to buy out my partner? All hypothetical questions I know. Was just thinking aloud. Thanks for the reply

 

[Finance Guy]

Hey DirtyWorks,

Lot's to cover here...

If you qualify for a Manifest (US Bank) equipment finance agreement you can usually choose your term and whether you want a residual or not on the back end. Let's say you want a 4 year term with no residual... You make your payments and after three years you want to upgrade. You can sell the machine you have and Manifest has a very small fee to release the UCC filings and opt out paperwork and you are done. You can take the money from the sale and put it towards a bigger machine and commence another EFA. You can also make all 48 payments and the machine is yours. Repairs are up to you. When the lease ends and you choose to return the machine there is not an inspection. There is no penalty for exsessive hours or wear and tear. If you had chosen to have a 10% residual on the end you can simply buy the machine for 10% of the original price. Now keep in mind your monthly payments would have been lower because in simple terms the bank lowers your monthly payments and puts it on the back end. If your business fails and you default on your payments then yes it will be a negative on your credit. Off balance sheet means the machine is neither an asset nor a liability. It would be a rental as far as the IRS determines.

Hoped this answered some of your questions...

Todd

 

[Countryboy]

Welcome to Heavy Equipment Forums DirtyWorks! :drinkup

 

[greywynd]

Finance guy, sent you an email....thanks for any assistance you can provide!