Many businesses need some kind of vehicle to conduct their operations. Landscapers and building contractors, for example, typically need multiple trucks and cars. When you decide to acquire a business vehicle, you have two options—buy or lease—and there are pros and cons to each.
While buying is usually a simple transaction, leasing can be a bit more complex. Therefore, it’s important to understand some key differences between the two, how vehicle leasing works, and steps to do so.
- There are many pros to leasing rather than buying a business car, including no down payment, lower monthly payments, and driving a new car every few years.
- Disadvantages of leasing include no deductions for depreciation, early termination charges, and additional fees for exceeding mileage.
- Before moving forward with a lease, there are many considerations, including what can and can’t be negotiated, terms and payment, and potential tax deductions.
- Carefully check the fine print and look for special deals and leasing discounts.
Should You Buy or Lease?
When you buy a car, you pay a significant down payment—and then you own a deductible asset. When you lease a car, however, you put down no money at all, pay a monthly fee, and are not considered an owner. So which is a better option for your business? Let’s explore the implications, pros, and cons of each.
Pros and Cons of Buying
When you own a car, you add to both your assets and your costs. Is that a good or bad thing? It depends on where you are financially, how well your business is doing, and what kind of vehicle is best for your needs.
A car adds to the value of your business.
You can depreciate your car every year, further lowering your taxes.
You can use the standard mileage rate or actual expenses method to deduct vehicle expenses.
If you need to, you can sell the car and recoup at least some of its value.
There are no strings attached; you can use the car any way you want for as long as it’s useful.
You must have the cash available for a multi-thousand dollar down payment.
You can’t deduct the cost of the down payment from your taxes.
Your car will lose value every day you own it.
Your monthly loan payments are typically higher than those of a comparable leased car.
Pros and Cons of Leasing
Leasing has its ups and downs, and your decision to lease will depend on whether you want to (or can) sink your business money into a car purchase. Here are some of the pros and cons.
Typically no down payment required.
Monthly leasing fees are usually lower than payments for car loans.
You can deduct the cost of maintenance and repair from your taxes.
If you decide to stop leasing at the end of the leasing period, you won’t need to worry about selling your car.
It is possible to transfer leases with no strings attached.
There is no deduction for depreciation.
If you use the standard mileage rate, the lease payment amount is also not deductible.
If you lease later in the year, you can only deduct costs related to the months during which you leased the vehicle.
A leased car does not positively impact the value of your business.
If you end a lease early, you will be responsible for paying penalties.
You may have to pay extra if your mileage is higher than the lease allows, which can be an issue if you need to drive a lot.
How a Business Car Lease Works
A lease is essentially a long-term car rental. However, because lease terms are somewhat lengthy (usually about three years), the cost can be much less than the cost to rent a vehicle. When you lease a car, you sign an agreement that is fairly complex and includes some small print.
Don’t make any assumptions about what a lease will require; for example, leases may include a number of fees that pop up at the end of the lease period.
It’s important to know that different companies have different policies and leasing options, so it can be worth your while to do some careful research. It’s also important to know that some aspects of a lease are negotiable, like mileage allowance and money factor (aka interest rates, depending on your credit score).
Before moving forward, consider a few important issues that could make a difference in your decision to buy or lease. These represent the “small print” in the paperwork, and could make a big difference in your costs and flexibility.
What Is Residual Value?
When a car leaves the lot, whether it’s leased or purchased, it instantly loses value. When it’s damaged in any way, the value drops again. Of course the leasing dealership wants to recoup as much of the value of the car as possible after it’s been driven for the standard three years. To make this happen, you and the dealership have to abide by what’s called “residual value,” meaning the value of the car at the end of its lease term, assuming typical wear and tear.
Residual value is determined by the bank holding your lease contract. It also signifies the lease-end purchase price and is typically nonnegotiable.
If the car you return is worth more than the residual value, you may make a little money. If it’s worth less (due to unexpected damage), you will owe the difference. Knowing this, it’s important to look for leased cars that are likely to retain 50% or more of their value after three years. If you damage the car, it’s also very important to have the damage repaired (ideally with insurance money) before the car is returned at the end of the lease.
Open vs. Closed Leases
When negotiating your lease, you may have the option of an open-end versus closed-end lease. An open-end lease requires you to take responsibility for the car’s residual value at the end of the lease, while closed-end requires you to take financial responsibility for the condition of the car (i.e., any excessive wear and tear).
With an open-end lease, you are responsible for paying for wear and tear on the car, but may also receive a refund if the car you return is worth more on the market than the guaranteed residual value.
In a closed-end lease, the lessee is not required to purchase the vehicle at the end of the term. While the terms in this type of lease may be more restrictive, the lessee does not assume the cost of deprecation—that falls on the lessor.
If your lease ends early, you may be charged an early termination fee, which is the difference between the payoff amount remaining on the lease and the realized value of the vehicle, meaning the amount the leasing company would receive for the vehicle if it’s sold.
According to Kelley Blue Book, depending on the lease, mileage agreements can range from 10,000 miles per year to as many as 15,000 miles per year. Once you exceed that mileage, you’ll be paying a per-mile fee anywhere from 12 to 30 cents per mile. If you drive a vehicle regularly for business, the miles can add up rapidly. That’s why it’s so important to estimate your monthly mileage and compare that mileage to any proposed lease. If you typically drive much more than the distance specified, you can negotiate the mileage or consider buying rather than leasing a car.
Lease Term and Payment
The average car lease term is 36 months, and the average cost is $460 per month. Your payment and lease terms, however, can vary based on a wide range of factors including:
- Make and model of car
- Length of lease
- Open or closed lease
- Mileage limits
- Drive-away payment
- Availability of specials and discounts
Typically, you’ll work with a dealership to negotiate all the elements of the lease so that you’re getting the best deal for your particular needs. If you find that negotiation still leaves you paying more for the lease (including fees, mileage, and monthly payments) than you’d pay for an acceptable vehicle purchase, you may decide that a purchase is a better deal.
There are a few tax issues to consider when leasing a business vehicle. When you lease, you’re doing so with pre-tax dollars. Let’s say you need to make a $50,000 purchase for a car and equipment. That purchase costs your business $50,000 and your lease payments can be written off as a business expense.
If you’re leasing a car for business, you can take advantage of the IRS’s Section 179 deduction, which allows you to take an immediate deduction for business expenses related to depreciable assets such as equipment and vehicles. To qualify, a business vehicle must be used for business purposes more than 50% of the time.
How To Lease a Vehicle for Business
Here are the steps involved with leasing a car for your business.
- Decide what you want and need in a leased car and write it down. Include your mileage needs and price range.
- Do your research to find reputable dealerships that lease cars, and check for special deals.
- Once you have a couple of good options, ask to see a standard lease agreement and read it carefully. Ask about warranties, drive-off fees, and allowable mileage.
- Work with your dealer to negotiate the best agreement.
- Sign the paperwork and pay the driveaway price. Before you get behind the wheel, however, you’ll want to be fully insured. You may also want to invest in gap insurance, which covers the difference between what a vehicle is currently worth (which your standard insurance will pay) and the amount you actually owe on it.
Frequently Asked Questions (FAQs)
Where can I lease a vehicle for a business?
You can lease vehicles at dealerships across the country. Banks and auto manufacturers also may have their own leasing programs. In addition, the National Vehicle Leasing Association (NVLA) has a free membership site with access to leasing companies, dealers, and private lessors around the country.
How do I inform the DMV of a returned business vehicle I leased?
It depends on your state’s laws. Check the website of your local DMV or contact its office with specific questions pertaining to business vehicles and leasing concerns.