Everything you need to know about buying versus leasing.

By Mark E. Battersby

Is it better to buy or lease? That is a question facing many chiropractors and others in the healthcare industry. While virtually everyone understands the simplicity of buying, leasing is far more complicated. Deciding the best strategy is a tough move for anyone and, obviously, there is no one correct answer that fits every situation, or every chiropractic practice.

According to the Equipment Leasing and Finance Association’s (ELFA) Monthly Leasing and Finance Index (MLFI-25), which reports economic activity for the $521 billion equipment finance sector, the medical industry’s preference for leasing equipment continues unabated, driven by demographics linked to the “baby-boomer” generation.

This flies in the face of the potential negative impact that healthcare reform legislation could have on the sector, along with various proposed reimbursement cuts, taxes, etc. And overall new business volume for January 2011 was $4.2 billion, up 24 percent compared to the same period in 2010 — despite changes in the tax laws permitting a 100 percent write-off for many new equipment acquisitions.

Why should you lease?

Equipment leasing is generally a loan in which the lender buys and owns equipment and then “rents” it to you at a flat monthly rate for a specified number of months. At the end of the lease period, you may purchase the equipment for its fair market value (or for a predetermined amount), continue leasing, lease new equipment, or return it.

Although lease financing is generally more expensive than bank financing, in most instances it is more easily obtained. One recent survey by the Equipment Leasing Association (ELA) found that among the Small Business Administration’s State Small Business Contest winners, almost 70 percent leased equipment.

The top reasons given by small business owners for leasing include the ability to have the latest equipment, see consistent expenses in budget management, help manage company growth, and avoid down payments.

Leasing offers real advantages, including reduced cash outflows and greater control. But that’s not all. A short list of leasing advantages includes:

• Conventional bank loans usually require more money up front than leasing, which generally requires only one or two payments up front in lieu of the substantial down payments often required with purchases.
• Unlike some financing options, leasing offers 100 percent financing. That means your practice can acquire essential operating equipment and begin using it immediately to generate revenues with no money down.
• Best of all, the full amount of the equipment, as well as service, shipping costs, and maintenance can be included in the lease. This spreads the cost over the term of the lease, freeing up cash flow for a practice that needs it.
• Leasing provides a hedge against technological obsolescence by allowing chiropractors to upgrade their equipment at the end of the leasing term.
• At the present time, an operating lease is not considered to be a long-term debt or a liability; it does not show up on a lessee’s financial statements. This makes the practice more appealing to traditional lenders down the road or when financing is needed. Naturally, a tax professional should be consulted to determine what percentage of other types of leases can be deducted.

When is buying better?

Ownership and tax breaks make buying business equipment appealing for many chiropractors, but high initial costs mean this option isn’t for everyone. Among the advantages of buying the equipment needed by the practice:

• The most obvious advantage of buying is that you gain ownership of the equipment. This is especially true when the property has a long useful life and is not likely to become outdated in the near future.
• Tax incentives: Imagine an immediate expensing write-off that, unlike Section 179, is not limited to use by smaller chiropractic practices, or capped at a certain dollar level. The 2010 Tax Relief Act boosted 50-percent bonus depreciation to 100-percent for qualified investments made after September 8, 2010, and before January 1, 2012. The new law also allows 50-percent bonus depreciation for qualified property placed in service after December 31, 2011, and before January 1, 2013.

Last fall’s Small Business Jobs Act also increased the Section 179, first-year expensing dollar and investment limits to $500,000 and $2 million, respectively, for 2010 and 2011. The Tax Relief Act provides for a $125,000 dollar limit and a $500,000 investment limit for tax years beginning in 2012 and “sun-setting” after December 31, 2012.

Understand that there are also disadvantages to buying:

• For some chiropractors, purchasing practice equipment may not be an option because the initial

cash outlay is too high. Even if you plan to borrow the money and make monthly payments, most banks require a down payment of around 20 percent. Borrowing money may also tie up lines of credit, and lenders may place restrictions on your future financial operations to ensure the loan will be repaid.
• Ownership is perhaps the biggest advantage to buying business equipment, although it can also be a disadvantage. If you purchase high-tech equipment, you run the risk that it may become obsolete, and you might have to reinvest in new equipment long before planned. Certain business equipment has very little resale value. A computer system that costs $5,000 today, for instance, may be worth only $1,000 or less three years from now.

Tax strategies to consider

The tax benefits associated with a lease are also important. Whether the ever-vigilant Internal Revenue Service treats a leasing transaction as a lease, or treats it as a purchase, will determine who is entitled to deductions for expenses such as depreciation, rent, and interest expenses.

The rules for determining whether a transaction is a lease or a purchase have evolved from a series of court decisions and IRS rulings. Generally, when it comes to determining who is the owner of the property for tax purposes, the IRS looks to the “economic substance” of the transaction — how it is structured and works — not how the parties involved characterize it.

There is no time limit on leasing. In fact, leasing is effective even in situations where you have already purchased equipment. These transactions, known as sale-leasebacks, are usually available for equipment purchased within the past 90 days. Sale-leasebacks may also be used to legitimately shift the tax benefits from your practice to its principal or principals.

Equipment or property already on the operation’s books may be sold to the chiropractor, principals in the practice, or to key employees, and then leased back to the practice. Because these self-rental transactions involve shifting tax benefits from the practice to its principal, they should be “arm’s length” transactions and the parties aware of possible IRS scrutiny.

Changes in the wind

New leasing standards proposed jointly by the Financial Accounting Standards Board and the International Accounting Standards Board have been characterized as naïve, lacking value, and in need of serious reevaluation. The outcry comes not from a handful of opponents but from companies on both sides of common lease contracts — those that rent office space, equipment, or airplanes, and those that own the assets.

At the center of the maelstrom is the “right-to-use” asset concept, the accounting mechanism that places leased assets and liabilities on the balance sheets of lessees, as if they owned the assets. That would essentially eliminate operating leases.

Should these accounting standards be adopted as proposed, it is the banks and other lending institutions that would be impacted first and hardest. With lenders forced to increase their capital and new restrictions on the sources of funds those institutions rely on, you might face a tighter — and more expensive — leasing market.

Down to the fine print

You can analyze the costs of a lease versus a purchase by using a “discounted cash flow analysis.” This compares the cost of each alternative by considering: the timing of the payments, tax benefits, the interest rate on a loan, the lease rate, and other financial arrangements.

However, while this sort of analysis is useful, a lease/buy decision cannot be made solely on cost analysis figures. While taxes play a role in the decision of whether to lease or to purchase, it should not be the deciding factor.

In general, those with a strong cash position and good financing options can often buy needed equipment outright or they can borrow to acquire equipment with a long operating life. If obsolescence is a concern, a short-term operating lease often provides the biggest advantage and the most flexibility.

Remember, however, short-term savings often result in higher costs over the entire leasing period. This is especially true with a finance lease where you can purchase the equipment at the end of the term. You could end up paying more over the long run. Obviously, it pays to determine any end-of-lease costs beforehand.

A startling eight out of 10 businesses lease some equipment, according to another study by the ELA. Over the long term, would your practice benefit from a lease?

Mark E. Battersby is a tax and financial advisor, freelance writer, lecturer, and author with offices in suburban Philadelphia. He can be reached at 610-789-2480.

DISCLAIMER: The author is not engaged in rendering tax, legal, or accounting advice. Please consult your professional advisor about issues related to your practice.