Tips for buying a new commercial vehicle (Part I)
Buy or lease? There isn’t a simple answer. There are a number of factors to consider. You need to understand these before making the commitment.
The first thing to know is that there are two totally separate types of leases for vehicles and equipment: a “capital” lease and an “operating” lease.
Traditionally, vehicles are normally handled as operating leases while equipment such as forklifts trucks or sheet metal machinery are typically capital leases. However, even that is changing as leasing is getting more sophisticated. There is a trend toward using capital leases for commercial vehicles.
The criteria for a capital lease can be any one of the following four options:
- Ownership. The ownership of the asset is shifted from the lessor to the lessee by the end of the lease period.
- Bargain purchase option. The lessee can buy the asset from the lessor at the end of the lease term for a below-market price.
- Lease term. The period of the lease encompasses at least 75 percent of the useful life of the asset (and the lease is non-cancellable during that time).
- Present value. The present value of the minimum lease payments required under the lease is at least 90 percent of the fair value of the asset at the inception of the lease.
If a lease agreement contains any of the preceding four criteria, the lessee records it as a capital lease. Otherwise, the lease is recorded as an operating lease. Your external accountants will set this up in your year-end financial statements if you don’t have the in-house expertise.
The original intent behind the capital lease is that you are likely to keep the asset to the end of its useful life. Now that commercial vehicles are also being leased as capital, this is changing. Either way, you are responsible for all the repairs and associated costs. The advantage of the capital lease is that the asset will show up on your balance sheet as an asset.
A truck lease that is set up as an operating lease does not have any of the above criteria and therefore there is no balance sheet entry — no asset value.
It is generally easier to lease as you often don’t put any money down, there is no deposit and the monthly payments are lower. However, does “No money down” mean no security deposit? You may have to pay a deposit, plus the first month’s rental plus and related fees.
Even where there is no deposit and lower monthly payments you should remember that you don’t end up owning the vehicle at the end of the lease. If cash flow is a major issue then leasing is an attractive option, provided the deposit, the security deposit and any other fees do not outweigh a purchase. If profit and equity building is important, then buy the vehicle using a loan.
There is no preferential tax treatment when comparing a lease to a purchase — you get to write off the actual expense. If this is a commercial vehicle used 100 percent for business then there is no personal tax benefit. In a lease you write off the full monthly payment; in a purchase you only write off the interest and write off the depreciation. Because you are purchasing the asset, the expense portion of your cash flow is lower than in a lease.
In a lease, 100 percent of the cash flow is an expense. There is no equity. In a purchase, your equity portion is a depreciation write-off over the life of the asset. When you sell the asset, you may get more than the book value for it. That means you have likely overclaimed depreciation so you will have to write back the difference to profit.
All of your operating expenses, fuel, repairs, insurance, etc., are expensed whether it is a purchase or a lease. If you do modifications and repaint the vehicle you could likely expense those in one year or write them off over several years, depending on the amount. Review this with your accountant.
Normal wear and tear are expected when you return a vehicle at the end of the lease. In a lease, you don’t have ownership so you are accountable to the owner for any damage beyond that and accountable for excess mileage. There have been recent cases where dealers have been very aggressive in charging for this because the residual value of the vehicle is lower than they anticipated. When the dealer takes back the vehicle, it wants to make a profit on the resale. The dealer can do this in two ways: by selling the vehicle for more than the buy-back allowance or by hitting up the lessee for excess damage and wear and tear. Most commercial vehicles do take quite a pounding over the years. You will also likely have to return the vehicle to its previous condition besides normal wear and tear. That means you may have to have it repainted to get rid of your HVAC market branding and you will have to dismantle any racking and shelving. And there is the excess mileage charge which can range from 10 cents to 20 cents per mile.
One strategy is to consider buying out the vehicle at the end of the lease so that you don’t have to comply with any of those conditions and then to use the vehicle for a while longer or resell it. Reselling it with the modifications could make it more valuable to another contractor.
Getting out of a lease can be extremely difficult. Go to the website www.leasebusters.com and see the number of people trying to get out of their leases. Recently there were owners of 140 trucks, excluding minivans and SUVs, trying to get out of their leases across Canada. Some have no mileage restrictions others have substantial charges for excess mileage. This could be a good source of acquiring a vehicle that is already on lease or getting out of a lease you are stuck in.
Usually businesses are clear on their need for commercial vehicles and less likely to need to get out of a commercial lease than a privately owned car; however, you do want to be aware of all the implications of what is required when you return the vehicle or if you need to terminate the lease early.