Which Is Better for Tax Write-Offs: Lease or Finance?

If you need business equipment, the options are to buy for cash, finance or lease. Cash or financing result in basically the same tax consequences. A lease works out a little differently as far as taxes go. However, as a small business, you qualify for other tax breaks on equipment, which may turn the question of finance or lease into a negligible factor tax-wise.

If you purchases business equipment paid using conventional financing, the tax treatment of the equipment is the same as a cash purchase. You can depreciate and write off a portion of the equipment value each year. How fast you can depreciate and write off the purchase depends on the type of equipment. The interest on the loan used to purchase business equipment will also be a deductible expense.

The tax treatment of a lease depends on whether it is an operating lease or a capital lease. With an operating lease, the equipment goes back to the leasing company at the end of the lease. With this type of lease, the lease payments are tax-deductible expenses. With a capital lease, there is a low residual -- such as 10 percent of the value -- at the end of the lease and the equipment is usually retained by the business after the lease terminates. A capital lease is treated in the same manner as regular financing for tax purposes -- you must depreciate the equipment value.

The section 179 tax deduction allows a small business to write off up to 100 percent of the purchase price of equipment for the year when the equipment was obtained. For 2013, the maximum deduction is $500,000 worth of equipment. The equipment purchase limit to use the section 179 deduction is $2 million for the year. For example, if you bought $800,000 worth of equipment, you can take a $500,000 deduction and depreciate the balance. The section 179 deduction can be used with equipment purchased with financing or by capital lease.

If you are a small business and spend less than $2 million per year on equipment, it really does not matter whether you finance or use a capital lease to obtain equipment. The section 179 deduction allows you to write off all or a large portion of the cost in the year of purchase. The section 179 deduction is optional, so use it if it helps with taxes or depreciate the equipment if that works out better. Operating leases are a direct tax deduction, so use this type of financing for equipment that will be replaced on a regular basis, such as computer equipment.