Equipment Loans vs Equipment Leasing: Which Suits Your Business?

Quick overview

Equipment loans and equipment leasing are two common ways businesses acquire the machines, vehicles, and technology they need. A loan buys the asset (with the lender often taking a security interest until repayment). A lease grants use of the asset for a period under contract terms; ownership usually remains with the lessor unless you exercise a purchase option.

This article explains how each option affects cash flow, taxes, balance-sheet presentation, and long‑term business strategy. It also includes practical comparisons, real-world examples, negotiation tips, and a decision checklist you can use when evaluating offers.

(For detailed tax rules, consult a CPA or see IRS guidance such as Publication 946 and Section 179 information.)

How equipment loans work

• Lender provides capital (a lump sum) to purchase equipment. The business owns the equipment immediately but typically grants a security interest to the lender until the loan is paid.
• Repayments are usually fixed monthly payments of principal plus interest for a set term (commonly 2–7 years for many types of equipment).
• The borrower records the equipment as an asset and claims depreciation over the asset’s useful life; interest is recorded as an expense.

Pros

• Ownership at payoff, which builds equity in the asset.
• Potential to claim depreciation and any available immediate expensing (e.g., Section 179), subject to IRS rules (see IRS Pub. 946).
• No mileage or usage limits imposed by a lessor.

Cons

• Higher monthly payments than leases for the same equipment price, all else equal.
• Upfront down payment may be required.
• You bear obsolescence risk — the asset can lose value, or technology can become dated.

Real-world example: A landscaping company finances a $120,000 truck with a 5‑year loan. Monthly payments are higher than a lease on the same truck, but after five years the company owns the vehicle and can continue to use or sell it.

How equipment leasing works

• The lessor buys and owns the equipment and grants you the right to use it for the lease term in exchange for periodic lease payments.
• Lease structures vary: operating leases (use-focused) and finance/ capital leases (which resemble loans and may transfer risks/benefits of ownership). Lease-end options commonly include return, purchase at residual value, or renewal.
• Many leases offer lower initial outlays and lower monthly payments than loans because you’re paying for the equipment’s depreciation and use during the term.

Pros

• Lower upfront cash and monthlies improve near-term cash flow.
• Easier upgrades: at term end you can return equipment and lease new models.
• Off-balance-sheet treatment was previously possible for operating leases, but accounting standards now require many leases to be recognized on the balance sheet — ask your accountant about ASC 842.

Cons

• You don’t build equity unless you purchase at term end.
• Total long-term cost may exceed buying, depending on residuals and fees.
• Lease contracts can include penalties for excessive wear, overuse, or early termination.

Example: A tech startup leases $60,000 of servers for three years. Payments are lower than loan payments and the startup can upgrade to newer hardware when the lease ends.

Cost comparison: how to calculate which is cheaper

Compare total cost of ownership (loan) to total leasing cost over the same useful period. Key items to include:

• Loan: loan principal + total interest + maintenance + opportunity cost of down payment – disposal/sale proceeds at end of useful life + tax effects (depreciation, Section 179, bonus depreciation) and interest tax deduction.
• Lease: sum of lease payments + fees + maintenance (if the lease requires it) + purchase option price (if you plan to buy) – tax effects (lease payments may be deductible as an operating expense).

A simple method: compute the net present value (NPV) of both cash‑flow streams using your business’s after‑tax discount rate. The lower NPV option is generally the better economic choice.

Practical tip: include likely residual values and realistic maintenance costs. Many small-business owners forget disposal/re-sale value when comparing alternatives.

Tax and accounting implications (what to ask your CPA)

• Tax deductions differ: equipment owners depreciate the asset (and may use Section 179 expensing or bonus depreciation subject to IRS limits); lease payments are generally deductible as an operating expense for lessees (verify with your tax advisor) (IRS Pub. 946; see IRS Section 179 rules).
• Accounting: Under U.S. GAAP (ASC 842), many leases create a right‑of‑use asset and lease liability on the balance sheet. The classification (operating vs finance lease) affects income‑statement presentation and metrics like EBITDA.
• Sales and use tax: Some states tax leases differently than purchases; sometimes sales tax is due on each lease payment rather than a lump-sum at purchase.

Because tax and accounting treatment changes based on lease terms and current law, always run scenarios with your accountant and reference authoritative guidance (IRS, FASB) before deciding.

When to choose a loan vs when to choose a lease

Choose an equipment loan if:

• You want ownership and plan to use the equipment longer than the loan term.
• You expect to benefit from depreciation or Section 179 deductions now.
• You can afford the higher monthly payments or down payment and prefer to avoid ongoing lease restrictions.

Choose an equipment lease if:

• You need to conserve upfront cash or maintain flexibility to upgrade frequently.
• The technology or equipment becomes obsolete quickly (IT, medical imaging, etc.).
• Your priority is predictable operating expense treatment and possibly easier approval with weaker credit (some lessors focus on the asset’s value rather than business credit).

Negotiation and underwriting tips

• Get multiple offers and compare APRs, fees, residual values, and early termination penalties.
• For leases, negotiate the residual value — a higher residual lowers monthly payments but increases the buyout at term end.
• Ask about maintenance packages, end‑of‑term fees, and damage allowances.
• For loans, ask about prepayment penalties, balloon payments, and the possibility of refinancing.

Common mistakes and how to avoid them

• Mistake: Comparing only monthly payments. Solution: Compare total cost (NPV) and include tax impacts and residuals.
• Mistake: Ignoring balance‑sheet impact. Solution: Confirm how the contract will affect financial covenants, debt ratios, and EBITDA with your CFO or CPA.
• Mistake: Overlooking end‑of‑term obligations in leases (restoration, disposal, or purchase). Solution: Read the lease fine print and budget for potential end‑of‑term costs.

Decision checklist (practical next steps)

1. Project expected useful life of the equipment and update cash‑flow forecasts.
2. Request detailed quotes with itemized fees, residuals, maintenance obligations, and purchase options.
3. Run an NPV comparison including tax and accounting impacts with your accountant.
4. Consider impact on financial statements and lending covenants.
5. Negotiate residuals, maintenance, and early termination terms.
6. Choose the product that optimizes cash flow, tax, and long‑term strategy for your business.

Further reading and internal resources

• Read our deeper comparison on equipment financing and tax impacts: Equipment Financing vs Leasing: Pros, Cons, and Tax Impacts.
• For practical tax and end‑of‑term options, see: Equipment Financing Explained: Taxes, Terms, and End-of-Term Options.
• If you need a comparison vs. business loan structures, try: Equipment Financing vs Term Loans: Which Fits Your Business?.

Authoritative external sources: IRS Publication 946 (Depreciation), IRS Section 179 guidance, U.S. Small Business Administration loan resources, and FASB ASC 842 lease accounting standards (consult each for current rules).

Frequently asked questions

Q: Can I finance used equipment?
A: Yes. Both loans and leases commonly cover used equipment; however, used equipment can change underwriting (shorter terms, lower advance rates, higher rates), so get specific quotes.

Q: Will a lease hurt my balance sheet?
A: Under ASC 842 many leases produce a right‑of‑use asset and lease liability on the balance sheet. The effect on metrics depends on classification (operating vs finance lease) — check with your accounting advisor.

Q: Are lease payments tax‑deductible?
A: Often yes for operating expenses, but the exact treatment depends on contract type and tax rules. Work with your tax professional.

Professional disclaimer: This article is educational and not personalized tax or legal advice. Consult your CPA or financial advisor for advice tailored to your company’s facts and the current law.

If you want, I can help you build an NPV comparison template using your expected purchase price, term, rates, residual values, and tax assumptions.