Is tax reform really impacting the lease vs. buy debate?
I have enjoyed asking Siri and Alexa questions and listening to their answers. One of my favorites is Siri's response to the question, "what is zero divided by zero?" Go ahead, ask her.
We are inquisitive by nature. Other than toddlers, the workplace may be the number one place questions come up. These questions, problems and opportunities are typically analyzed and parsed out every day. Currently, a popular question among us finance people is, "should we lease or purchase fleet vehicles?"
Regular evaluation is the key
All organizations should continually ask and evaluate how to most effectively use their limited resources. The lease versus buy question is being asked more frequently in response to the new lease accounting rules as well as the tax reform bill enacted this past December.
I would encourage you to learn how the lease versus buy question was initially answered in your organization. At some point in your business' history, this question was asked, answered and implemented.
But now, what you have to determine is, is the initial answer still valid? Are the anticipated economic benefits being achieved? Hopefully, the answer is, "Yes."
Now ask what has changed in your business. Are your business objectives the same as they were years ago? Are you conducting business differently?
The impact of new leasing accounting standards
The new lease accounting rules have changed and will require leased assets and liabilities to be recognized on the balance sheet. This means your fleet vehicle leases must be on the balance sheet. These rules are intended to provide quality information to investors.
However, the new accounting rules have not changed the benefits of leasing. A decision to lease or buy should remain focused on the economic benefits without allowing the accounting rules to shortcut the answer. The change in lease accounting does allow us to evaluate the impact to lease versus buy. But, the rules should only have an impact on which approach is the most economically beneficial to your organization.
The impact of tax reform
We are learning and implementing the most significant tax reform bill since 1986. The reform includes several big wins with a reduced corporate tax rate, repeal of AMT (alternative minimum tax) and accelerated depreciation methods.
Per the tax guidance, motor vehicles have a useful life of five years. Most fleet vehicles are replaced within less than five years. As a result, most of the depreciation benefits are recaptured at termination, resulting in a taxable gain. Recapture of depreciation was possible prior to the tax reform. Depending on the accelerated depreciation method used will determine how much recapture is computed.
Further, the tax reform bill includes a provision to limit the ability to deduct interest expense. Prior to tax reform, the interest limitations focused on foreign-owned U.S. companies. Now, the interest limitations apply to all organizations. If a bank loan is used for purchasing vehicles, then the deductibility of the loan's interest expense could be limited for tax purposes.
But wait, there's more
Another factor to consider is the cost of funds compared to the interest rate charged in the lease. Consider the following:
- Are the funds cheaper from the leasing company or from the bank?
- Do you want the burden of residual value risk?
- Will financial resources be more valuable invested in your fleet or in another area of the business?
- Does your organization have a surplus in cash to prevent borrowing?
As always, please consult with your internal and external finance colleagues. They will hold the answers to most of these questions. And if you need the fleet management perspective, please feel free to reach out to us or download our lease vs purchase eBook.
Siri comically points out that zero divided by zero does not make sense. Lease versus buy will make sense when you narrow your focus to the economic benefits.