If your business needs new equipment, you probably want to know about your financing options. In this blog article, we’ll break down the similarities, differences, and pros and cons of two of the most popular equipment lease options: $1 buyout leases and fair market value (FMV) leases.
What Is a $1 Buyout Lease?
A $1 buyout lease is a type of capital lease, which means you own the equipment or property throughout the life of the lease (and afterward too). The leased equipment will show up on your balance sheet as an asset. A $1 buyout lease can also go by other names; you might hear it called a capital lease or an equipment finance agreement (EFA).
Compared to a typical operating lease, where you strictly lease the equipment and the leasing company or financing partner (the lessor) still owns the asset, a $1 buyout lease “feels” more like a loan. The lease gets its name because, at the end of the lease period, you’ll complete the payments on the asset for a nominal price, often $1.
But when it comes time to make monthly payments (or however often your lease term specifies), the $1 buyout lease resembles a lease more than a loan. Your $1 buyout lease won’t have stated interest rates like a loan would. Instead, you’ll make fixed payments, and the finance charges get rolled into your payments.
So, you can think of a $1 buyout lease (a.k.a. equipment finance agreement) as a sort of hybrid between a loan and a lease. You may be able to get 100% financing with no down payment and fixed payments like you would with a lease. However, you own the equipment from the time of purchase, and the equipment appears on your balance sheet, similar to a loan.
Business owners who are purchasing equipment tend to like $1 buyout leases because they’re straightforward, streamlined, and easy to understand. Also, when you finance an equipment purchase with a $1 buyout lease, you may be able to write off the entire cost of the equipment in the first year as “bonus” depreciation under the Tax Cuts and Jobs Act. This bonus depreciation is available for any qualified asset that you purchase and put into use before 2023.
Why Would I Want a $1 Buyout Lease?
Since you own the equipment, a $1 buyout lease often makes sense when you’re looking to purchase a piece of equipment that will stay in use for many years and retain most of its value.
Examples of the types of equipment we’ve helped clients acquire with $1 buyout leases include:
- Cranes
- Excavators
- Tractors
- Bulldozers
- Refrigerated trucks
- Dump trucks
- Food packaging assemblies
- Lathes
- CNC machines
- Box makers and sealers
- Grinders
- Machine presses
- Industrial coolers
- Transportation and freight vehicles
What Is an FMV Lease?
A fair market value lease (FMV lease) can be a type of operating lease, which means it functions more like a rental agreement compared to a $1 buyout lease. With an operating lease, you don’t own the equipment you’re leasing. However, the payment structure is similar to a capital lease (like the $1 buyout lease): you may be able to get 100 percent financing with no down payment, and you’ll make fixed payments until the end of the lease term.
At the end of the term, you’ll usually have the option to purchase the equipment at the current fair market value (FMV), which is where the FMV lease gets its name. You can also choose to continue making your lease payments and using the equipment. If you don’t want to exercise your purchase option or continue leasing the equipment, you can return it and walk away. FMV leases tend to last between one and five years.
Why Would I Want an FMV Lease?
So, why would you want to lease without the benefits of ownership? For some types of new equipment that go out of date quickly and lose most of their value, ownership doesn’t have many benefits.
Think about a computer as a classic example: when you buy a new computer, it will lose most of its value in the first few years, so you can’t resell it for anything close to what you paid for it. In five to ten years, technology will move on to the point that the computer will have almost no resale value, no matter how cutting-edge it was when you bought it.
Other equipment types that we’ve helped customers acquire with FMV leases include:
- Fork trucks
- HVAC systems, solar panels, LED lighting, and other energy needs for buildings
- Office equipment, like copiers, printers, storage cabinets, and phone systems
- IT equipment, like servers and software
Comparing FMV and $1 Buyout Leases
Which type of equipment financing is right for your business? Both FMV leases and $1 buyout leases have pros and cons:
FMV lease:
- Pros:
- Tend to be very affordable
- Easy to keep equipment up to date; you can return old equipment and lease newer equipment when the lease term ends
- Scales well; you can get the right amount and type of equipment you need now, and then adjust as needed. You don’t have to make newer assets work alongside older ones, which is especially useful in fields like IT, where compatibility can be an issue.
- Your financing partner deals with equipment management and disposal
- Reduced cost for use of the equipment
- Option to walk away from the equipment when the lease ends
- Lease is usually shorter in term
- Some tax benefits (can deduct monthly lease payments as an operating expense)
- Many business owners can get 100 percent financing with no down payment
- Cons:
- May be more difficult to finance used equipment or highly specialized items
- May involve stricter requirements to qualify
- Doesn’t give ownership of the equipment (can also be a “pro”)
$1 buyout lease/equipment finance agreement
- Pros:
- You own the equipment
- Excellent tax benefits; you may be able to take 100 percent bonus depreciation in the first year
- Many business owners can get 100 percent financing with no down payment
- Cons:
- May cost more, since you purchase the equipment and receive ownership
- You’re responsible for equipment management and maintenance
Which solution works best often comes down to the type of equipment you want to finance. An FMV equipment lease usually makes sense if your business needs to stay current, and you update equipment frequently. If you plan to use the asset for a long time or think you can sell it for a good value when you’re finished using it, then a $1 buyout lease may be the best solution.
RELATED: Business Health: How Equipment Financing Can Help Your Cash Flow
Contact Team Financial Group to Learn About Your Equipment Financing Options
Have questions about which type of financing option makes sense for your business or whether you qualify? We’re here to help. Call Team Financial Group today at 616-735-2393 or fill out our contact form to talk with a financing expert from Team Financial Group. And if you’re ready to apply for financing, fill out our quick online application and let us do the rest.
Reference
IRS. New rules and limitations for depreciation and expensing under the Tax Cuts and Jobs Act [press release]. (2018, April). Retrieved from https://www.irs.gov/newsroom/tax-law-offers-100-percent-first-year-bonus-depreciation
The content provided here is for informational purposes only. For personalized financial advice, please contact our commercial financing experts.