Equipment Financing vs. Capital Lease: Pros and Cons

Quick comparison

• Equipment financing: you borrow money to buy equipment; the business is the legal owner (often subject to a security interest) and capitalizes the asset and loan.
• Capital lease: you lease equipment under terms that transfer most ownership benefits and obligations to you for accounting and tax purposes; the lease may be treated like an asset-and-liability on your balance sheet.

How each option works in practice

Equipment financing is a loan where the financed equipment frequently serves as collateral. Lenders range from banks and credit unions to specialty equipment lenders and captive finance arms. Repayments cover principal and interest; when the loan is paid off you own the equipment outright (unless a lease-purchase option already existed). See our deeper primer on Equipment Financing for lender types and application basics.

A capital lease (often called a finance lease in accounting standards) is a contract that allows you to use equipment for a fixed term. The lease is structured so the lessee effectively gains the economic benefits and burdens of ownership — for example, when the lease term covers most of the equipment’s useful life or there is a bargain purchase option. Many lenders treat capital leases as on‑balance-sheet obligations. For more on lease structure and common lease clauses see our Capital Lease Loan.

Key differences: ownership, balance sheet, and cash flow

• Ownership: With equipment financing you are buying the asset and will hold title (subject to lender’s lien). Capital leases typically place title in the lessor’s name during the lease, but you carry the asset’s economic risks and rewards and often have an option to buy at the end.

• Balance sheet: Equipment financing creates an asset (equipment) and a loan liability. A capital lease is recorded as a leased asset and a corresponding lease liability under current accounting rules.

• Cash flow and payments: Financing often requires a down payment and higher monthly debt payments (principal + interest). Capital leases may offer lower initial cash outflow and monthly payments because the lease amortization is structured differently, but total cost over time can be similar or higher depending on rates and fees.

Tax and accounting considerations (practical points, not tax advice)

• Depreciation vs. lease deductions: When you finance equipment, your business can generally capitalize and depreciate the asset and deduct interest on the loan. Under a capital lease treated as a financing arrangement for tax/accounting, you usually capitalize the asset and claim depreciation while deducting interest-like imputed interest on the lease liability. For lessor-structured operating leases (different from capital leases), lease payments may be deductible as ordinary business expenses.

• Section 179 and bonus depreciation: Many businesses can use Section 179 expensing or bonus depreciation to accelerate tax deductions on purchased equipment. Whether a leased asset qualifies depends on lease terms and tax rules. Check IRS Publication 946 and the IRS Section 179 guidance, and consult your CPA for your year’s limits and qualifications (rules and dollar limits change with tax law and inflation adjustments) IRS Publication 946 and IRS Section 179.

• Accounting standards: U.S. GAAP and IFRS require most finance-style leases to be reported on the balance sheet as both an asset and a liability. That affects debt ratios and covenant calculations — an important consideration if you monitor DSCR or borrow against receivables. See our article on Debt Service Coverage Ratio (DSCR) for how new liabilities can change lender views.

Pros and cons (summary)

Pros of equipment financing

• You own the asset and can sell or modify it.
• Potential to use Section 179 or bonus depreciation (consult CPA).
• No usage limits or return restrictions imposed by a lessor.

Cons of equipment financing

• Higher initial cash outlay or down payment.
• Monthly payments may be higher.
• You bear residual value risk and maintenance costs.

Pros of a capital lease

• Lower upfront cash requirements and predictable monthly payments.
• Easier access to cutting-edge or high-cost equipment for businesses with limited capital.
• Depending on lease language and local tax law, monthly payments may be treated as deductible expenses (or you may capitalize the asset and deduct depreciation/interest).

Cons of a capital lease

• Total cost over the lease term can be higher than buying.
• Lease terms may restrict use, transfer, or modification.
• You may face early termination penalties or residual value adjustments.

When each choice often makes sense

• Choose equipment financing when: you plan to use the equipment long-term, want to build balance-sheet equity, need the tax benefits of ownership, or you expect a long useful life that outlasts financing terms.

• Choose a capital lease when: conserving cash is a priority, you need rapid access to equipment, you expect to upgrade before depreciation runs out, or your balance-sheet and tax objectives favor leased capacity. Startups and seasonal businesses often prefer lease structures for flexibility.

Practical evaluation checklist (step-by-step)

1. Estimate total cost of ownership: compare loan interest + down payment + maintenance vs. lease payments + fees + buyout.
2. Run the impact on cash flow: create a monthly cash-flow projection for the term (include expected downtime, maintenance, and tax impacts).
3. Check accounting and covenant impacts: will adding a lease liability trip a loan covenant? Speak with your lender or CFO.
4. Ask about end-of-term options: purchase price, fair-market-value buyout, renew, or return terms.
5. Confirm maintenance obligations and insurance responsibilities in the lease.
6. Run tax scenarios with your CPA for Section 179, bonus depreciation, and interest deductibility.

Real-world examples (illustrative)

• Construction company: Financing a $200,000 excavator over five years may mean higher monthly payments but full ownership at term-end. The company uses the machine for a decade, so ownership and depreciation benefit their long-term margins.

• Technology startup: Leasing servers with a capital lease (or short-term operating lease) reduces upfront capex, lets the firm upgrade every 2–3 years, and keeps cash available for hiring and product development.

These scenarios are typical in practice but outcomes depend on contract terms, interest rates, and tax treatment.

Common mistakes to avoid

• Failing to read lease termination and buyout clauses — early exit can be expensive.
• Ignoring residual value risk when buying — resale value can drop faster than expected.
• Overlooking how lease liabilities affect loan covenants or credit metrics.
• Assuming tax rules are the same every year — depreciation and Section 179 limits change.

FAQs (short answers)

• Can a capital lease lead to ownership? Yes. Many capital leases include a bargain purchase option or transfer of ownership at term-end.
• Are lease payments always deductible? Not always; deductibility depends on lease type and tax treatment. Consult a CPA.
• Which is cheaper long-term? Ownership can be cheaper if you keep equipment beyond the financing term, but this depends on interest rates, maintenance, and residual value.

Links and next steps

• Learn more about buying equipment and lender options in our deeper guide: Equipment Financing.
• If you want details on lease structures and clauses, see: Capital Lease Loan.
• For a holistic comparison, review our feature: Equipment Financing vs. Leasing: Which Is Right?.

Professional disclaimer and sources

This article is educational and not individualized financial or tax advice. For advice tailored to your situation, consult a CPA, tax attorney, or financial advisor.

Authoritative sources consulted:

• IRS Publication 946, How To Depreciate Property: https://www.irs.gov/publications/p946
• IRS page on Section 179 deduction: https://www.irs.gov/businesses/small-businesses-self-employed/section-179-deduction
• Consumer Financial Protection Bureau: https://www.consumerfinance.gov

In my practice helping small businesses evaluate capital equipment decisions, the best outcomes come from running simple cash‑flow comparisons, checking covenant impacts, and confirming tax treatment with your CPA before signing. Following that three-step process usually prevents costly surprises.