Many companies lease or finance equipment without considering the differences in expense deduction methods between a true lease or loan. It's only after year-end when tax time arrives that they find out the type of lease or financing they chose did not maximize their possible deductions for that and future years.

The end of lease residual or purchase option is the primary factor that determines the tax handling of your lease. Every for-profit company in the U.S. has an amount of capital equipment they can purchase each year that can be fully expensed under I.R.S. Section 179. If your company has not exceeded the annual limit, then a finance lease with a $1.00 residual may be the choice for you.

On the other hand, if you have met your maximum capital purchase deduction for the year or regularly do so, you may want to choose a true lease with a fair market value residual or purchase option not less than 10% of the original equipment price.

Since the total monthly payments of a true lease are normally expensed each year, you may be able to accelerate your equipment depreciation if the lease term is less than the term required to depreciate the asset under it's classification. You will also save in the accounting costs associated with creating and managing depreciation schedules.

Another important factor in choosing your lease is weighing the benefits versus disadvantages between longer and shorter terms.

Longer terms can provide for lower monthly payments and increased annual cash flow for revenue producing assets. The main disadvantage to longer lease terms is the higher balance you will have to pay off if you want to trade out of the equipment or buy-out the lease early for any other reason. If the equipment you are getting does not retain it's value, depreciates in value quickly, or regularly becomes obsolete, it may be wise to choose a shorter term.

The two primary benefits to a fair market value lease, which may or may not qualify as an operating lease (off balance sheet financing), are that you may be offered below market rates and you have the power to negotiate the end of lease purchase price. Best of all, you can use the equipment at a low rate, just turn it back to the leasing company at the end, and lease new state of the art equipment with up-to-date technology.