Every construction company owner gets to a point when he/she has to decide about new equipment. There’s a lot that goes into the decision. However, some wish they had a cheat sheet to help them through the process, and here it is.
When considering the purchase, there are several financial plans, which are shared below. However, the biggest decision to make is whether to lease or buy the equipment. Both have their pros and cons. Each may be dependent upon where your business is in its life cycle. Companies in their infant stages may decide to lease to gain assets and to reduce overhead. More mature companies may choose the same option for a different reason—to be able to get rid of the equipment when the owner decides to exit the business. Companies with an established history, and that plan to stay in the industry, may choose to buy.
To Buy or To Lease
Heavy equipment purchases come with a hefty price tag and can put a real strain on your business’ working capital. However, there are options that can infuse a lifeline into new businesses and can help those struggling due to the lack of heavy equipment options.
Leasing heavy equipment is similar to leasing a car. The business makes up-front payments to the lender, basically a loan, and in turn “rents” the equipment for a flat monthly fee. When the lease period is fulfilled, the owner generally has the option to buy the equipment for its fair market value, continue leasing, lease new equipment, or return it.
Buying heavy equipment is also like buying a car. The depreciation impact is immediate. The owner has the full burden of the acquisition, meaning the owner is responsible for the equipment’s resale. The asset may not be worth much when the owner goes to sell it.
If you are considering this route, be sure to work with leasing company or financing sources who have been in business for at least as long as your new lease would last. Also, be choosy when it comes to casualty insurance and terms. Your goal is to ensure your purchase is covered in case of damage, for repairs, or when needed to pay personal property tax.
• Frees up a business line of credit.
• Upgrades in the future may be done more easily.
• Deductions as a business expense apply.
• Works well when you’re short on working capital.
• Helps outfit the company with equipment that may not be part of your long-term strategy.
• Options to customize contractual end-of-terms.
• Write-downs are immediate.
• Choices for flexible payment terms.
• Simplifies balance sheet management (when properly leased).
• Generally requires less of a down payment.
• Upfront costs for new or start-up companies may need personal funding via line of credit or investment.
• Higher price paid over the long term.
• Commitment to the equipment for a long period of time.
When you commit to buying equipment, it should be reflected in your business model about how you will manage that equipment and its resale period. This helps you to budget maintenance costs, depreciation, taxes, and to watch for the best market in which to sell the equipment for profit.
• You own the equipment and you control what to do with it in the future.
• If you do not have outstanding debt or have a strong balance sheet, purchase approvals may be swift.
• Depletes working capital/increased down payment generally required.
• May put a strain on the business.
• May require another large investment to upgrade the equipment.
• If you have a less-than-stellar credit or the business has a lot of debt, purchase approvals may take longer or could be denied.
Using all your business cash to buy heavy equipment is not a smart business move.
Remember, many types of heavy equipment qualify for financing, such as scrapers, bulldozers, trucks, heavy construction equipment, machining assets, concrete equipment, and more. Here are several financing options to consider when deciding if you should lease or buy equipment.
• Installment or Secured Business Loan: This option allows for interest-expense deductions and depreciation. You may also trade-in current equipment or provide a low down payment with structured payments over time. The good thing about this option is you own the equipment when paid it’s off. However, it could make it more difficult to have ready cash if more or newer equipment is needed while you’re paying the financing company.
• Operating Lease: This is basically a rental agreement with the option to return the equipment at the end of the lease term or to extend the lease with the option to buy. It is “rented” for a set period of time.
• Capital Lease: In this financial arrangement, the lessee has an ownership interest in the equipment, which means you may report the lease as an asset and a corresponding liability.
• Fair-Market Value: This is a good option if you’re concerned about the value of the equipment when the financing is complete or if you want to make a small security deposit with low monthly payments. At the term end, you have three options, including extending the term, returning the equipment, or buying the equipment at its (then) fair market value.
• 10 Percent Security Deposit: This option is attractive if you can afford the down payment, which helps reduce monthly payments and decreases the overall loan amount. End-of-term options apply, including extending the agreement or returning the equipment and requesting the security deposit.
• 10 Percent Purchase Option: In this case, the upfront amount is applied to the end of the term payment. At the end of the term, you have the option to buy the equipment at ten percent of the original cost, continue to finance it, or return it.
• $1.00 Buy-Out: This option applies when you know you want to buy the equipment upon term end. You may then buy it for $1.
Tax season is not far away, and heavy equipment purchases can provide a much-needed boost to your tax deductions. However, the equipment must be in service before the end of the year for it to be claimed on your business taxes.
Effective January 1, 2014, the maximum Section 179 deduction amount for property placed in service is $25,000, and the deduction is reduced dollar-for-dollar by the cost of qualified personal property placed in service greater than $200,000. More than one item may be used to qualify for the $25,000 deduction.
To learn more about how the costs are applied and the amount that may be deducted, read the IRS Section 179 webpage at http://www.irs.gov/publications/p946/ch02.html.
In the end, no matter if you choose to buy or lease construction equipment it should not tie up your company’s cash flow. It should work within your business plan and help to generate or even increase revenue while you have it.
Lastly, working with experienced advisors who have assisted other construction companies with their financing and their tax deductions is recommended. There’s no reason to go it alone. In fact, the goal is to move your company forward.