Equipment Leasing

Gregory J. Cook, EA, CPA, Accredited Tax Advisor

Equipment leasing has become an increasingly popular program, both for the investor and for individuals or companies that rent equipment. For the investor, it has provided some attractive tax benefits. For the company renting and using the equipment, it:

• allows capital to remain free for other purposes;
  

• keeps debt off the company balance sheet;
  

• provides an easier and possibly less expensive means of financing; and
  

• eliminates the problem of what to do with equipment which may have become obsolete after years of use.

Many types of equipment may be leased. Some examples are computers, aircraft, equipment used for oil drilling, railroads, cable television, the medical field, pollution control devices, solar energy devices, and a myriad of other types of personal property. Note, however, that real property is not included in this group of investments.

In order to remain an equipment leasing arrangement (rather than some other arrangement which does not receive the same tax benefits), the IRS requires that at least 20% of the equipment purchase price be provided by the investors, and they must be at risk for at least that amount. This is just one of many tests the IRS applies in determining whether or not an equipment leasing investment falls within its guidelines.

Tax benefits include some we've already discussed, such as depreciation, deductible interest and operating expenses, many of which are up-front deductions. The at-risk rules apply to equipment leasing ventures.

Other benefits include the cash flow, the possibility of a residual value at the end of the leasing term, and less economic risk since the investment involves tangible property. Along with that lower risk, of course, is the expectation of a lower return.

Many of the potential problems already discussed also apply to equipment leasing arrangements. These include the at-risk rules and the stringent tests the IRS applies to an equipment-leasing program to determine that it is, indeed, a lease rather than a conditional sale. Finally, for typical investors in a limited partnership arrangement, interest is one of the expenses that contributes to a passive loss. As a result, it is deductible only to the extent of passive income.