Capital Leases leave equipment on your balance sheet and allow you to purchase the equipment at lease end. With a capital lease, you’re treated as owner of the leased equipment, and the lease remains on your balance sheet.
Operating Leases take equipment off your balance sheet; instead, they appear on your income statement as an operating expense. This off-balance-sheet financing lowers the debt to equity ratio, raises the current ratio (liquidity), and raises return on assets (ROA).
True Leases can generate tax benefits compared to owned assets. With owned equipment, the IRS allows depreciation and interest expense deductions, but doesn’t allow deduction of principal payments. Depreciation deductions for owned equipment follow a predetermined schedule set by the IRS.
With a true lease, your entire lease payment can be deducted from taxable income, allowing you to write off equipment expenses more quickly than if you owned the equipment. You can expense the use of the equipment over the term of the lease, usually five years. The shorter write-off period means a larger deduction each year, lower taxable income and decreased tax expense. The net result is an increase in your tax flow.
Lease Purchases entitle you to depreciation deductions because you are treated as the owner of the asset for federal income tax purposes.
Be sure to consult an accountant about which type of lease is right for you.