Company Vehicles: Lease vs. Buy
If you need to purchase a company vehicle, you have two basic choices: Buy or lease. Which option makes better sense for your business depends on how long you plan to keep the vehicle and how many miles it will typically be driven.
When you buy a vehicle, you pay the entire cost of the vehicle. You make a down payment, pay sales taxes, and make payments (if you financed the purchase). You can later decide to sell or trade in the vehicle.
When you lease you only pay a portion of the vehicle’s cost. You may or may not have to make an up-front payment, pay sales tax only on monthly payments (at least in most states), and pay a monthly fee to lease the vehicle. At the end of the lease, you can return the vehicle or purchase it outright.
So, what matters most to you and your company? Getting a new vehicle every two to three years with no risk of major repair costs or long-term savings by owning the vehicle for a number of years? Would you prefer to pay off a vehicle and enjoy a period with no monthly payments? Would you prefer to pay more per month but have no long-term ownership and responsibility for the vehicle?
Advantages of leasing a vehicle
For many businesses, leasing is usually the better option. Businesses enjoy a significant tax advantage by leasing rather than buying company vehicles. If the vehicle will be solely used for business purposes, you can also deduct the full cost of all monthly payments as well as all operating costs. Initial costs are typically much lower as well. Also:
- Leasing offers tax advantages. Monthly payments are deductible; purchased vehicles must be depreciated over a number of years.
- Most leases cover maintenance and repairs. The cost of maintenance and repairs for purchased vehicles excluding items covered under warranty is covered by the business.
- Vehicles do not have to be sold at the end of their service life. Turning in a leased vehicle eliminates the need to sell older vehicles in your fleet.
Advantages of purchasing a vehicle:
The primary reason to purchase a vehicle instead of leasing is if you plan to keep it for at least five years; after five years (a standard rule of thumb) the financial advantages of leasing decrease. Also:
- Customization. If the vehicle must be customized like, for instance, a service vehicle buying could make more sense.
- Extreme usage. Most leases allow 12,000 to 15,000 miles per year; if the vehicle will be driven more extensively, the lease will charge a per-mile fee for that use.
- Tax advantages for eco-friendly vehicles. Not all hybrids qualify, and programs can change or be phased out, so stay up to date on current requirements and tax breaks.
How can you decide whether to lease or buy?
The key is to determine which factors are most important.
Lease if you want a new vehicle every two to three years, are interested in lower monthly payments, want a vehicle that is always under warranty, drive a fairly low number of miles, do not need to customize the vehicle, and do not want to build asset value through long-term ownership.
Buy if you are willing to keep the vehicle for more than five years, are willing to make slightly higher monthly payments with the idea that down the road you will have paid off the vehicle, are willing to face the risk of non-warranty repairs, need to customize the vehicle, and need to drive higher than average miles per year.
If you decide to lease a vehicle, here are some common terms you should know:
Capitalized cost: The price of the vehicle at the beginning of the lease.
Capitalized reduction: Down payment made at lease origination; creates a lower monthly payment, but requires cash out, minimizing one of the biggest advantages of leasing holding on to your company’s cash.
Closed-end lease: Vehicle is returned at the end of the lease without owing residual value (also called appraised/resale value), which is a fixed amount stated in the contract. If you need new vehicles every two to three years, you can roll over the lease to the latest model each time.
Depreciation: The dollar amount difference between a vehicle’s value at the beginning of the lease and at the end.
Early termination: Returning the vehicle to the leasing company before the term of the lease agreement is ended. Most leases stipulate an early termination penalty or fee.
Excess wear and tear: If a leased vehicle sustains excessive damage through careless driving habits or lack of routine maintenance, you will be charged for repairs.
Gap protection: Waives the difference between what the vehicle insurance policy covers if it is stolen or totaled, and the amount still owed on the vehicle.
Mileage allowance: Standard mileage limits are 12,000 to 15,000 miles per year. Any number over the limit typically costs an average of 15 cents a mile. Higher mileage limits can be negotiated.
Open-end lease: The option to buy the vehicle at its fixed residual value; if the vehicle is worth less than that amount at the end of the lease, you must pay the difference. Leases, whether closed or open, typically do not include insurance, but may include license and title fees. Some leases require the first and last month’s payments, or a refundable security deposit, at signing.
Residual value: The appraised value of the car at the end of the lease after depreciation, used to set a sales price if the lessee wishes to purchase the car. In general terms, the higher the residual value the lower the monthly payments.