Purchase vs. Lease after the JCWAA

Should equipment be purchased or leased? The Job Creation and Worker Assistance Act of 2002 (JCWAA) may change the after-tax cost of each alternative. This item evaluates a taxpayer's decision to purchase or lease by comparing costs.

The JCWAA added "bonus depreciation" rules for assets purchased between Sept. 10, 2001 and Sept. 11, 2004. Bonus depreciation is an additional 30%, first-year depreciation deduction on new equipment, which reduces the basis of the asset used to calculate regular and alternative minimum tax depreciation.

Example: Company X is in the transportation business. It is considering the tax implications of either financing the purchase of certain assets or leasing them.

Lease: If X were to lease equipment, the pre-JCWAA tax savings from the lease payments (assuming a 34% marginal tax rate) would be $68,000 annually ($200,000 x 34%). The present value (PV) of the tax savings over a five-year period, assuming an 8% return rate, would be approximately $271,508 ($68,000 x 3.99271); see Exhibit 1.

Purchase: The purchase price of the equipment is $800,000. X made no down payment. Pre-JCWAA, the PV of the tax savings resulting from the depreciation and interest deductions would be $263,067; see Exhibit 1.

On the other hand, under the JCWAA, the bonus depreciation on the assets is $240,000 ($800,000 x 30%). The depreciable basis for the asset is reduced to $560,000 ($800,000 – $240,000). The PV of the tax savings from the depreciation and interest deductions is $276,907; see Exhibit 2.

In the example, pre-JCWAA, X's tax benefits in leasing assets exceeded those of purchasing them by $8,441. However, post-JCWAA, the situation reverses; the tax benefits of purchasing exceed those of leasing by about $5,400; see Exhibits 1 and 2.

The purchase of equipment is a critical decision for most businesses—particularly for emerging businesses. Present and future cashflow considerations are often the deciding factor. Post-JCWAA, the after-tax benefits of purchasing equipment would appear to exceed the benefits of leasing. However, for many businesses, cashflow is a critical factor in their capital-expenditure decisions. Clearly, over the first two-to-four years of a purchased asset's life, the taxpayer's nondiscounted cashflow is noticeably increased; see Exhibits 3 and 4.

The figures support the premise that the post-JCWAA benefits of purchasing equipment exceed those of leasing. However, a lease-vs.-buy analysis should include all the facts and circumstances; each situation is unique.

From J. Del Walker, CPA, Robert L. Trahan and Liping Gao, PKF of Texas, P.C., Houston, TX