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IS A LEASE TAX DEDUCTIBLE – Saving Countless Hours of Explanation During Tax Season

Posted 12/30/2019

 It is very common for a taxpayer to walk into a tax office and proudly proclaim “I have a lease, therefore I get to deduct it” and our answer is always “MAYBE”.  A lease doesn’t translate in to more or less deductions than had the asset been purchased.  It depends on many things.  After Sept 11th, 2001, the immediate write-off of assets (Code Section 179) was greatly increased and Bonus Depreciation was introduced, making leases less favorable.  The entire point of a lease, under the old law, was to get the deductions faster.  With Section 179 election at $500,000, most clients find a true lease a restriction, not a help.  Over the years, the IRS and the courts have been clear regarding leases.  There are two basic categories:

1)      A True Lease (think rent) where you are gaining no ownership, no equity, no credit toward purchase, you are ONLY paying to the use of the property for a period of time and then you’re done.  Some describe this as “throwing your money away”.

2)      A Capital Lease (think loan) which looks more like a financing agreement.  Payments go toward ownership and the longer you “lease” the less you pay in the end to own the asset.  Often the IRS will reference the existence of a “Bargain Purchase Option” (BPO).  An example of a BPO is “after ten years of lease you pay $5 and you own it”.  Any predefined value and transfer of ownership would make the lease a Capital Lease (treated as a loan), with or without a BPO. 

What is the tax difference?  In the case of a True Lease, the payments are deducted when paid, just like any rental arrangement. 

A Capital Lease gets setup on the Depreciation Schedule just like buying any other asset with a loan.  The applicable depreciation elections may be utilized, Sec 179 and/or Bonus Depreciation.  By declaring “I have a lease and therefore I get to deduct my payments” you are really saying “forgo the immediate write-off of up to $500,000 and take my deduction over time”.  This may not be what you want or need.  In general, leases just are not as beneficial as they were 20 years ago.      

Our advice:  Seek a qualified tax accountant before entering into any lease and let the accountant read the lease document.  Sales people are not tax accountants, they are sales people and some will tell you anything to make a sale.  Caveat Emptor!