Quick overview

When a business needs equipment, the two most common paths are buying with a loan (equipment financing) or entering a lease. Each choice changes your cash-flow profile, balance sheet, and tax deductions in different ways. Below I explain practical pros and cons, typical tax treatment under current IRS guidance, real-world examples, and decision tips I use when advising clients.

How each option works in practical terms

  • Equipment financing: A lender provides funds (or the borrower uses capital) to purchase equipment. The equipment is collateral for the loan. Payments consist of principal and interest. The borrower records the asset on the balance sheet, claims depreciation and may deduct interest and related fees on the tax return.

  • Leasing: A lessor owns the equipment and grants use to the lessee in exchange for periodic payments. Most operating leases let the lessee treat payments as operating expenses and do not record the asset on the balance sheet for tax purposes (though modern accounting standards may require balance-sheet recognition for leases). At lease end the lessee typically returns, renews, or buys the equipment at a predetermined price.

Tax highlights and rules to check

  • Ownership vs. rental: If you finance and own the equipment, you generally recover the cost over time through depreciation (and may be eligible for immediate expensing under Section 179) and you can deduct interest on the loan to the extent it’s business-related. See IRS Publication 946 (How To Depreciate Property) and Form 4562 instructions for Section 179 details IRS Pub 946 and Form 4562.

  • Leases and deductibility: Lease payments for an operating lease are generally deductible as a business expense by the lessee (check IRS Publication 535 for business expense rules) IRS Pub 535. However, some leases are treated for tax purposes as a conditional sale or financing arrangement (often called a ‘‘finance lease’’ or historically a ‘‘capital lease’’) and then the lessee must capitalize the asset and claim depreciation.

  • Section 179 and bonus depreciation: Section 179 allows businesses to elect immediate expensing for qualifying property up to a statutory dollar limit (the limit is adjusted periodically; check the current Form 4562 instructions). Bonus (additional) first-year depreciation has been available for qualified property but the availability and percentage are subject to statutory phase-downs. Because these amounts change, confirm current-year limits with IRS guidance before assuming a write-off amount [see Form 4562 and IRS Pub 946].

  • Sales tax and incentives: Some states tax leases differently than purchases. Also, government or manufacturer incentives may make leasing more attractive for short-lived or fast-depreciating equipment.

Pros and cons — a practical checklist

  • Equipment financing (buy via loan)

  • Pros: You gain ownership; potential long-term cost savings; you can claim depreciation and possibly Section 179/bonus depreciation; you can sell or trade equipment when you wish.

  • Cons: Higher upfront cash or down payment; monthly payments can be higher (principal + interest); responsibility for maintenance and obsolescence rests with owner.

  • Leasing

  • Pros: Lower or no upfront cash; predictable monthly expense; easier to upgrade or return equipment at lease end; potential off-balance-sheet treatment for operating leases (varies by accounting standard).

  • Cons: Total long-term cost may be higher; no ownership unless you exercise a buyout; some lease contracts include maintenance, end-of-term fees, or strict usage limits.

Accounting and financial statement differences

  • Balance sheet: Financed purchases are capitalized as fixed assets with an associated liability. Operating leases may show only the expense (but check financial reporting rules: many leases now produce lease assets and liabilities on the balance sheet for GAAP/IFRS reporting).

  • Cash flow statement: Financing typically shows loan proceeds and principal repayments; leasing shows operating cash outflows for payments (which can improve certain cash-flow ratios).

Real-world examples (from my client work)

  • Example A — Heavy equipment (financing): A construction client borrowed to buy a $250,000 excavator. Ownership let them use tax depreciation and eventually sell the machine. The loan required a down payment but reduced the client’s long-term cost compared with multiple lease terms.

  • Example B — Rapidly changing technology (leasing): A marketing agency leased servers and high-end computers on three-year terms. Leasing reduced the agency’s risk of owning obsolete equipment and kept monthly cash needs lower during growth phases.

These are typical patterns I see in practice: capital-intensive, long-lived assets often favor financing, while short-life or fast-obsolescence assets often favor leasing.

When a lease looks like a purchase (important caveat)

Not all leases are simple rentals. If a lease includes provisions that transfer ownership, provide a bargain purchase option, or cover most of the asset’s useful life, the IRS or tax accounting may treat it as a purchase/finance transaction for tax purposes. That changes whether you deduct lease payments or claim depreciation. Review the lease terms carefully and confirm tax treatment with a CPA.

Calculating total cost of ownership vs. lease cost

Don’t decide on monthly payments alone. Build a total-cost model that includes:

  • Upfront cash (down payment, fees)
  • Monthly payments (principal/interest or lease rent)
  • Maintenance, insurance, and downtime costs
  • Tax effects (depreciation, interest, Section 179, lease deductibility)
  • Resale or residual value at end of term
  • Opportunity cost of capital

I recommend running both an after-tax cash-flow comparison over the equipment’s useful life and sensitivity tests (e.g., what if resale value is 20% lower than expected?).

Common mistakes I see

  1. Treating leasing as automatically cheaper—sometimes lower monthly payments hide higher long-term costs.
  2. Ignoring tax elections—failing to elect Section 179 in the year of purchase or misunderstanding bonus depreciation timing can change tax outcomes materially.
  3. Overlooking end-of-term obligations—return conditions and damage fees on leases can be costly.
  4. Not checking lender covenants—some loans restrict future borrowing or equipment use.

How to choose: a practical decision flow

  1. Define how long you’ll realistically use the equipment. If it’s longer than the lease term and resale value is reasonable, financing can be better.
  2. Model after-tax cash flows for both options over the expected holding period.
  3. Check credit, collateral, and covenant terms from lenders/lessors.
  4. Consider operational needs: do you need the latest technology or a long-term capital asset?
  5. Consult your tax advisor to confirm available deductions and any state-level rules.

Useful resources and further reading

For deeper operational or contract-level issues, see these related FinHelp articles:

Final tips from practice

  • Always read the lease contract for residual-value clauses, maintenance obligations, early termination fees, and end-of-term purchase options.
  • If tax outcomes matter, don’t assume the lease is deductible without checking whether the agreement qualifies as an operating lease for tax purposes.
  • For purchases, confirm whether you can use Section 179 or bonus depreciation in the year you place the equipment in service by checking the latest IRS guidance and Form 4562.

Professional disclaimer: This article is educational and does not replace personalized advice. Tax rules change and can vary by state. Consult a CPA or tax attorney before making decisions that affect your business taxes or long-term capital strategy.