Leasing equipment can be a smart option for business owners who are strategic about their purchases and keeping an eye on their budget.
How exactly depreciation works with leased equipment is complicated. Knowing the requirements for different scenarios can make a world of difference to businessowners’ back pockets.
In this article we will explore:
- What is depreciation?
- How does leasing equipment work for businesses?
- Can leased equipment be depreciated?
- Scenario one: fixed asset
- Scenario two: hire purchase agreement
- Scenario three: leasing equipment for a few days
What is depreciation?
Before we delve into if and how depreciation can be claimed on leased equipment, what exactly is it?
Depreciation is the natural wear and tear of a property and its assets over time. Businesses and commercial property owners can claim this wear and tear as a tax deduction each financial year.
There are only two categories that depreciation can be claimed under. The first being capital works on the structure of the property and any fixed assets.
Plant and equipment is the second category and can be claimed on easily removeable or mechanical assets. A lot of leased equipment falls under this category and can include cleaning equipment, machinery such as excavators or forklifts and freestanding furniture.
How does leasing equipment work for businesses?
The second element of this question is defining what leased equipment is and the parties involved.
Leased equipment is generally ‘borrowed’ under a contractual arrangement. Unless it’s a ‘hire to purchase’ agreement, the party that leases the equipment (the lessee) simply returns it to the owner (the lessor) at the end of the contract.
Leasing equipment can be a cost-effective option for businesses. Not only does it mean a low upfront cost, but it’s a solution for equipment rarely used.
Can leased equipment be depreciated?
Establishing whether a business owner can claim depreciation on equipment they lease is a complex topic and doesn’t necessarily have a black and white answer.
The key point that must be determined is who is the ‘holder’ of the asset. Essentially, the holder of the asset can claim depreciation on it. The holder can change based on the leasing scenario, here are a few examples.
Scenario one: fixed asset
If a leased asset is fixed to the lessee’s land, depreciation is essentially broken into two parts.
The lessor can claim depreciation on the actual asset as they are the holder and have the right to remove the asset. However, the lessee doesn’t necessarily miss out on depreciation completely. They can claim depreciation on any assets they use to fix the equipment to the land and claim a deduction on the cost of holding the equipment.
|In practice: fixed asset depreciation
Fred is a mechanic and owns a block of land where he builds a workshop for his car repair business.
His business set-up costs are high, so he decides to lease some machinery from a finance company, including automotive lifts and a large air compressor.
The finance company holds the machinery as it has the right to remove it from the property. So, only the finance company can claim depreciation on it.
However, Fred also holds the assets, and they are attached to his land. Therefore, he can claim a deduction based on the cost of him holding the machinery. This doesn’t include his lease payments but would include things like the cost of installing the machinery and his own fixtures.
Scenario two: hire purchase agreement
Sometimes, the lessee can enter a ‘hire to purchase’ agreement with the lessor. While each arrangement differs, it usually works with the lessee paying an agreed amount over a set period. At the end of the period, they then pay a discounted sum to own the asset. This amount is a lot lower than the market value.
As the lessee is ‘reasonably likely’ to purchase the asset at the end of the hire purchase agreement, they are determined as the holder and can claim depreciation on it.
|In practice: Hire purchase agreement
Wendy owns a cattle farm and entered into a hire purchase agreement with a provider of a farming tractor. Wendy uses the tractor for her farm’s business operations.
Under the agreement, Wendy pays monthly hire payments, including an interest element over three years. At the end of the hire period, Wendy may acquire the tractor for 15 per cent of the original purchase value.
Given that Wendy is ‘reasonably likely’ to acquire the tractor at the end of the hire period, she is the holder of the tractor for depreciation purposes and can claim it as a plant and equipment deduction.
Scenario three: leasing equipment for a few days
Sometimes a business only needs to lease the equipment as a ‘one-off’ for a few days or weeks. Common examples of this include small machinery such as bobcats and mini excavators, or entertainment equipment like lighting and sound systems for events.
When it comes to who can claim what, these type of leasing agreements are very straight forward. The lessor is the owner and can claim depreciation on the equipment, while the lessee claims the leasing expense as a tax deduction for the financial year.
To learn more about how depreciation works for your scenario, Request a Quote or contact BMT on 1300 728 726.