Consolidated Professional
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Should you lease or buy your next vehicle?

You may have heard that leasing a business auto is smarter than buying one because of the tax advantages. It's true that leased vehicles receive better treatment under the tax law. But you still have to crunch the numbers to make this decision. A good purchase will almost always beat a lousy leasing deal, and vice versa.

When the deals are similar, you must calculate the "present value" (PV) of leasing and buying. The easiest way to figure the true cost of a lease is to take the PV of lease payments and costs, then subtract the PV of tax savings. To get the true cost of buying a vehicle, take the PV of purchase payments and costs and subtract the PV of tax savings.

The PV figure takes into account the applicable costs for each year discounted back to present value using an appropriate after-tax rate of return.

For example, if you lease, you'll probably have to pay up front fees, and you should consider buying "gap protection" insurance as well. These costs must be included in your analysis and discounted back to present value, say using an 8 per- cent discount rate.

In both the lease and buy cases, you'll probably have to pay sales tax and vehicle license fees up front. If you expect to keep the car after the lease expires, that amount should be included as a cost of the leasing alternative.

The best way to run the numbers is by example:

Business vehicles: lease- versus-buy analysis

LEASING: Say the vehicle you'd either like to lease or buy can be leased for 36 months at $399 with $2,000 upfront for the capitalized cost reduction payment plus another $2,000 for tax, title and license fees (TT&L).

In this case, your monthly lease costs would average $510 (36 monthly payments of $399 plus $2,000 for capitalized cost reduction and another $2,000 for TT&L, spread over the 36- month lease term). Assuming a late December 2001 acquisition date, 100 percent business use and a fair market value for the car of $34,500, your annual lease deductions would be:

Prorated annual expense Income inclusion. Net tax deduction

1 st year: $510 x 12 = $6,120 ($157) $5,963

2^nd year :$510x12= 6,120 ( 343) 5,777

3^rd year: $510x12 = 6,120 ( 510) 5,610

Total write-offs: $17,350

Income inclusion amounts effectively reduce your annual lease deductions and are found in IRS Publication 463, Travel, Entertainment, Gift, and Car Expenses.

BUYING: Assume now that you could buy the same vehicle for $34,500, plus TT&L of $2,000, with a down payment of $7,000. Your loan would be for $29,500 (total cost of $36,500 minus $7,000 down) over 36 months at 4.9 percent, resulting in monthly payments of $883. Included in those payments is $2,288 of interest ($1,126 in the first year, $769 in the second and $393 in the third).

Assuming 100 percent business use, your depreciation write-offs will be $3,060 for the first year, $4,900 for the second and $1,475 for the third, for a grand total of $9,435. Let's also assume you would sell the car after three years for $22,700 (same as the stated lease residual value). At that time, you would have a taxable loss of $4,365 (sales proceeds of $22,700 minus a tax basis of $27,065, with tax basis calculated as $34,500 purchase price plus $2,000 TT&L minus $9,435 depreciation).

If you buy the vehicle, your tax write-offs will total $16,088 ($9,435 depreciation plus $2,288 interest plus

$4,365 loss on sale).

Now that you've successfully identified all the tax write- offs, you can finish the lease-versus-buy analysis.

Cost of leasing alternative

Present value of lease payments $16,733 ($4,000 upfront plus 36 monthly payments of $399 discounted at 8 percent rate)

Present value of tax deductions ($5,217) ($482 for 36 months assuming 35 percent tax rate and 8 percent discount rate)

True cost of leasing = $11,516

Cost of buying alternative

Present value of payments $35,178 ($7,000 upfront plus 36 monthly payments of $883 discounted at 8 percent rate)

Present value of disposition price ($18,020) ($22,700 received at end of third year discounted at 8 percent rate)

Present value of tax deductions ($4,789) (Assuming 35 percent tax rate and 8 percent discount rate)

True cost of buying = $12,369

Based on the facts in this example, the leasing alternative is $853 cheaper on an after-tax, present value basis. Surprisingly, this is true even though the total cash outlay from leasing is $2,276 higher ($18,364 compared to $16,088).

Why does leasing come out ahead? Because with the lease you pay less upfront and get earlier tax write-offs. For this reason, competitive lease deals will often beat competitive purchase deals for autos used primarily for business. Note: This example doesn't mean leasing will always turn out better.

Strategy 1: While leasing often turns out to be the best choice for business vehicles, buying may be the smart move for a "heavy" SUV, pickup or van. Why? Because when you buy one of these machines with a gross vehicle weight rating above 6,000 pounds, you may be able to claim a Section 179 depreciation deduction of up to $24,000 in the year purchased. To qualify, it must be used more than 50 percent for business.

Strategy 2: Consider purchasing one of the models offer- ing zero percent financing as a buyer incentive. If you can also negotiate a really good purchase price, it may well beat any lease deal you could possibly make.

Personal vehicles: lease- versus-buy analysis

But what about personal autos? Actually, you can use the same basic approach here,

too. Just skip the initial part about tax benefits because there are essentially none for personal cars.

So here are the simplified equations for doing a lease- versus-buy analysis for a personal auto.

With leasing, the present value (PV) of lease payments and costs equals the true cost of the lease. When buying, the PV of the purchase payments and costs equals your true cost.

LEASING: For example, say the vehicle can be leased for 36 months at $429 with $2,500 upfront for the capitalized cost reduction payment plus another $2,000 for tax, title and license fees (TT&L).

In this case, the true cost of leasing would equal the pre- sent value of lease payments ($4,500 upfront cost plus 36 monthly payments of $429 discounted at 8 percent rate). Thus, the true cost of leasing would equal $18,190.

BUYING: Now assume you could buy the same vehicle for $33,000 plus TT&L of $2,000, with a down payment of $7,000 Your loan would be $28,000 (total cost of $35,000 less $7,000 down) over 36 months at a very favorable 2.9 percent rate, resulting in monthly payments of $813.

Let's also assume you would sell the car after three years for $22,700 (same as the stated lease

residual value). Here's the cost comparison:

Present value of payments $32,944 ($7,000 upfront plus 36 monthly payments of $813 discounted at 8 percent rate)

Present value of resale price ($18,020) ($22,700 received at end of third year discounted at 8 percent rate)

True cost of buying = $14,924

Based on this example, the buying alternative is $3,266 cheaper on a present value basis.

Why? In this case, you were able to secure a very favorable loan interest rate and an aggressively discounted purchase price because of buyer incentives offered by the dealer and manufacturer. However, the dealer's lease arrangements were not so heavily subsidized. Also, since we are talking about a personal vehicle here, there are no tax advantages to leasing over buying.

Rules of thumb: Business vehicles

When to buy

Purchaser pays cash rather than financing. Purchaser plans to hold auto for more than four years.

Auto weighs more than 6,000 pounds.

Purchaser plans high mileage usage (more than 18,000 miles/year).

When to lease

Lessee wants lower monthly payments. Lessee plans frequent trade-ins.

Auto weighs less than 6,000 pounds and costs more than $15,300.

Lessee plans low mileage usage (less than 15,000 miles/year).

Online resources: The lease/buy decision

www.businessguideusa.com wwwleaseguide.com www./easespy.com www.carpoint.msn.com www.autobytel.com www.autoadvice.com www.carinfo.com

Source: Journal of Accountancy. February 2001. ,

TO BUY OR TO LEASE -- WHICH IS BETTER?

There is a running debate on which is better -- to own or to lease a vehicle for use in your business activities.

From the buyer's or lessee's standpoint there are really three considerations (1) financial differences (2) income tax considerations, and (3) the lifestyle and emotional factors.

From the vehicle dealer's perspective, his interest and goal is to make the same profit on a given model whether he sells it or leases it. And he attempts to accomplish this with the mathematics included in the lease.

On a $25,000 vehicle, a customer (buyer or lessee) usually will pay from $100 to $150 less per month on a 36 month lease as compared to the payments on a 36 month purchase contract. But there are other factors to consider.

A buyer would own the vehicle at the end of the 36 month period in whatever condition it is in, paid-for, and with no further payments of any type.

A lessee would hand over the keys to the dealer at the end of the 36 month lease, and be without a vehicle and possibly owe the dealer more money, depending on a number of factors to be discussed later.

So, in the above comparison, the buyer of the vehicle would have paid from $3,600 to $5,400 more than the lessee over the 36 month term, but would then own the vehicle outright. The lessee would have paid $3,600 to $5,400 less than the buyer, but would be without a vehicle. Additionally, the lessee would be subject to some or all of the following restrictions and costs.

Virtually all leases include a limit on the number of miles the lessee is allowed to drive without additional charges over the monthly lease charge. In most leases the lessee is given two or more choices to select a plan that fits his or her particular driving habits.

Ii A typical monthly lease payment might include a maximum allowable 12,000 miles per year with an additional charge of 15 cents per mile for any miles over this amount or, an alternate amount of 15,000 miles per year with an additional charge of 12 cents per mile over the 15,000.

Additionally, lessees often have the option of prepaying for a selected number of miles over the allowable amount included in the monthly lease payments. The cost of these prepaid miles usually are significantly less per mile than the payment you would make at the end of the lease for any extra miles. In the 12 cents and 15 cents example discussed above, the prepaid miles might be 8 cents per mile. However, please be aware that the amount paid for prepaid miles usually reduces the residual value of the vehicle at the end of the lease term. (The residual value is the anticipated value of the vehicle at the end of the lease.) The residual value is predetermined by the dealer at the start of the lease. If the dealer determines the residual value at the end of the lease is less than the predetermined value because of excessive wear and tear, the lessee must pay the difference.

A lessee should discuss with the dealer what specific standards are used to determine excessive wear and tear before entering the lease agreement.

Income tax considerations also come into playas whether to buy or lease. In the previously discussed example, if you anticipate driving 20,000 miles per year and you buy and take the standard mileage rate of 32 cents per mile, your tax deduction would be $6,500 per year (32 cents x 20,000).

By leasing you would be able to deduct the $4,200 lease payments ($350 per month x 12 months), plus your actual gas, oil, and repair expenses plus your $750 extra mile charge (5,000 miles x 15 cents per mile). Assuming 20 miles per gallon, 20,000 miles would require 1,000 gallons, and at a projected price of $1.40 per gallon, your gasoline cost would be $1,400. So your lease cost ($4,200) plus your excess mile cost ($750) plus gasoline cost ($1,400) would total $6,350 or slightly less than the $6,500 projected operating cost of the "purchase" plan discussed above. However, the leasee has the option of forgoing the lease payment and actual expenses and, instead, taking the 32 cents per mile standard deduction with the same results as the buyer.

In a different scenario, let's say you selected a vehicle at twice the cost of the previously discussed one and projected only 10,000 miles business use.

By leasing you would be able to deduct the entire $8,400 lease payment ($700 x 12 months) plus your $700 gasoline cost (500 gallons x $1.40) for a total deduction of $9,100. You would not have any excess mileage charge. (All of the figures involving leased or purchased vehicles assume you are using the vehicle 100% for business use.)

If you bought, and elected to deduct actual expenses, your depreciation deduction (in lieu of lease payments) would be limited to $3,160 the first year (IRS limitation), plus $700 gasoline costs for a total of $3,860. If you elected to take the standard mileage rate, your income tax deduction would be $3,250 (10,000 miles x 32 cents each, a considerable amount less than the $9,100 deduction for leasing.

So, for individuals whose tastes naturally run to luxury cars, and who drive a limited number of miles, it would appear, tax wise, that leasing is better.

Other considerations for leasing are that, generally, most lease agreements require the following upfront costs be paid at the signing of the lease agreement:

1) The first month's lease amount,

2) A security deposit equal to an approximate amount of one month's lease payment, and

3) The sales or use tax

Some lease agreements will also include a "disposal" fee, a fee to compensate the dealer for cleaning up the vehicle and reselling it.

So, it is not possible to say whether leasing or buying is better for everyone. It depends on each individual's circumstances. Many variables are included in the equation.

Now, the good news is that recent federal law has required dealers to simplify the lease agreements and include plain language to describe the various contents. And, reputable dealers will give you a blank copy of their lease agreement to take home and review before entering an agreement. You should be able to analyze your circumstances and decide which is best for you.

And finally, if you, lease, each year you will need to add a lease inclusion amount into your income as has been discussed earlier in this chapter.

Car Shopping? Look Before You Lease

By KELLY K. SPORS
Staff Reporter of THE WALL STREET JOURNAL

Walk into a car dealer and you'll likely be tempted with an offer to lease instead of buy.

The pitch sounds good: low monthly payments, a short term and the chance to drive a new car. But you can get burned. Here's what to do before leasing:

Look into the future. If you plan to keep a car for many years -- say five or more -- you're likely better off buying it to avoid extra fees and taxes. And if you might move out of town or need to break the contract, don't lease. Contracts can cost thousands of dollars to terminate.

Wheel and deal. There's always wiggle room to negotiate the cost of leasing, says Tarry Shebesta, president of Automobile Consumer Services, Cincinnati, an independent leasing firm. He says consumers should negotiate the auto's purchase price before even discussing leasing. This method could reduce your payments by lowering the sales price the lease is based on. Negotiating the vehicle's overall price is most important, because it'll have the biggest effect on your monthly bill.

Other things to negotiate: acquisition fees, down payments and disposition fees (what you pay at the end if you decide not to purchase the vehicle). Don't sign anything until the terms are settled and written into the contract. Also, don't accept the first offer. Fees and terms can differ significantly from one lender to the next, so shop around before settling on one. (Independent lenders often sell better lease terms than what dealerships offer.)

When it comes to cost, don't tell the dealer what you can afford in monthly payments. Always negotiate on overall price.

Know your residuals. Lease terms are built on residual value -- the auto's predicted worth when the lease ends. Residual values often can't be negotiated since they're set by lenders, not dealers. That's why you should comparison-shop between lease offers for the best residual-value estimate.

Here's how it works: Your monthly payment is based on the negotiated sales price minus the residual value and any down payment you make. So if you've got a 39-month lease on a $30,000 vehicle with a $17,000 residual, your monthly payment would start around $333. (Or $13,000 divided by 39 months.) Other fees usually are added on to that, so the payment would be a bit more.

This means a higher residual is usually better, since it lowers your monthly payment. While it's hard to get a precise estimate, check out Edmunds.com's "True Cost to Own" database. It gives estimated depreciation on most new autos up to five years down the road.

When the lease ends, you have the option to "buy out" the vehicle for its residual value. If the auto is worth more than the residual listed in the lease, it's wise to buy it for that amount or less, if possible. If it's worth less than the residual, either return it or bargain with the dealer for a competitive price. Chances are they'll accept a lower price so they don't have to hassle with selling the used car.

Pin down costs. All leases contain "money factors"-monthly fees you have to pay on the lease, similar to an interest rate. But getting dealers to reveal money factors can be a tall order. In fact, sometimes only the dealer's finance manager will know the money factor on a particular vehicle. But finding it out is key to knowing whether you're getting a good deal.

"If you are financing a car, you'd know what the interest rate is," says Tony Langenderfer, an auto-buying consultant in Sarasota, Fla. "Leasing should be no different."

You want a lease to have a money factor similar to or less than the interest rate on a vehicle loan. Money factors usually are quoted in mysterious-sounding figures such as 0.00212. To see what this means in the real world, do a simple calculation: multiply the money factor by 2,400. For instance, a 0.00212 money factor (times 2,400) equals 5.09, equivalent to a 5.1% yearly interest rate.

Another expensive fee: excess mileage. If you drive over the allotted miles in the lease (typically 10,000 to 15,000 each year), you'll be charged, usually around 18 cents for every mile over. You can buy extra miles before signing the lease for about eight cents each.

Roll in the costs. Dealers often ask lease signers to pay up-front costs including a $200 to $850 acquisition fee mandated by the lender, deposit and down payment. But experts suggest it's best to get any costs you can't altogether eliminate rolled into the lease so you pay them monthly rather than ahead of time. Why? If the lease must be terminated, you won't lose all the money you spent up front -- just the amount you paid through monthly payments. Also check that "gap insurance" -- the insurance that covers you in case the auto is totaled -- is included in the lease and not an extra cost for you. Some lenders don't include it. But if you're comfortable with signing a contract, leasing can be beneficial. It's a way to drive new cars every few years and dodge the hassle of selling a used car. Moreover, newer cars tend to have lower repair costs. And leasing lets you test-drive a car for a few years before deciding to buy it. The calculator at www.leaseguide.com offers a breakdown of standard costs and lets you calculate what you are facing.

RECORDKEEPING

Whether you use actual expenses or the standard mileage rate, you must keep records to show when you started using your car for business and the cost or other basis of the car. Your records must also show the business miles and the total miles you drove your car during the year.

Actual Expenses. If you deduct actual expenses, you must keep records of the costs of operating the car, such as car insurance, interest, taxes, licenses, maintenance, repairs, depreciation, gas, and oil. If you lease a car, you must also keep records of these costs.

To claim a deduction for the expense of a car that you use in your business or work, you must be able to prove (substantiate) certain elements of the expense. You must be able to prove these elements by adequate records or sufficient evidence, either written or oral, that will support your own statement. Estimates or approximations do not qualify as proof of an expense. {This "either written or oral" is taken from IRS Publication 463. I have serious reservations about whether "oral evidence" would be accepted in an IRS audit.

I think, instead, it might cause the auditor to break up in uncontrollable laughter at the taxpayer!

Proof of Expenses. You must be able to prove:

1) The amount of each expense for a car, including the cost of buying a car and the cost of capital improvements. If you deduct actual car expenses, you must also be able to prove each separate expense for operating the car, such as lease payments, the cost of maintenance and repairs, or other expenses.

2) The mileage for each business or investment use of the car, and the total miles for the tax year.

3) The date of the expense or use;

4) The business or investment reason for the expense or use of the car.

Adequate Records. You should keep the proof you need for these items in an account book, diary, log, statement of expense, trip sheet, or similar record supported by adequate documentary evidence. Written evidence has considerably more value than oral evidence alone.

Timely Recordkeeping. You do not have to write down the elements of every expense at the time of the expense. However, a record of the elements of an expense or of a business use made at or near the time of the expense or use, supported by sufficient documentary evidence, has more value than a statement prepared later when generally there is a lack of accurate recall. A log maintained on a weekly basis, which accounts for use during the week, is considered a record made at or near the time of the expense or use. You do not have to record information that duplicates information shown on a receipt as long as your records and receipts complement each other in an orderly manner.

An adequate record contains sufficient information for each element of every business or investment use. The level of detail

required to prove the use may vary depending on the facts and circumstances. For example, if your only' business use of

a car is to make deliveries to customers of your employer on an established route, you can satisfy the requirements by

recording the length of the delivery route once, the date of each trip at or near the time of the trips, and the total miles you

drove the car during the tax year. You could also establish the date of each trip with a receipt, record of delivery, or

other documentary evidence.

Generally, an adequate record must be written. However, a record prepared in a computer memory device with the aid

of a logging program is considered an adequate record.

Receipts. A receipt is ordinarily the best evidence to prove the amount of an expense.

Canceled Check. A canceled check, together with a bill from the payee, ordinarily establishes the cost. However, a canceled check alone does not prove a business expense without other evidence to show that it was for a business purpose.

Business Purpose. A written statement of the business purpose of an expense is generally required. However, the degree of proof varies according to the circumstances in each case. If the business purpose of an expense is clear from the surrounding circumstances, a written explanation is not required.

Example. A sales representative who calls on customers on an established sales route does not have to submit a written explanation of the business purpose for traveling that route.

Sampling. You can maintain an adequate record for parts of a tax year and use that record to substantiate the amount of business or investment use for the entire year. You must demonstrate by other evidence that the periods for which an adequate record is kept are representative of the use throughout the tax year.

Example. You use your car for local business transportation to visit the offices of clients, meet with suppliers and other subcontractors, and pick up and deliver items to clients. There is no other business use of the car, but you and other members of your family use the car for personal purposes. You maintain adequate records during the first week of each month that show that 75% of the use of the car is for business. Invoices and bills show that your business use continued at the same rate during the later weeks of each month. Your weekly records are representative of the use of the car each month and are sufficient evidence to support the percentage of business use for the year. -

How Long to Keep Records and Receipts. You must keep proof to support your claim to a deduction as long as your income tax return can be examined. Generally, it will be necessary for you to keep your records for 3 years from the date you file the income tax return on which the deduction is claimed. A return filed early is considered as filed on the due date.

Illegal Car-Leasing Traps

There are many virtues for consumers to leasing a car, but dealers push leasing for one main reason-it is often more profitable for them than selling cars outright.

Despite major investigations and new disclosure requirements for lease contracts, it is easy to mislead consumers about the costs of leasing versus buying. Common traps...

BOGUS LEASE RATES Leasing companies and dealers are not required to disclose the effective Annual Percentage Rate (APR) on a car loan.

Instead, a dealer may disclose only the lease factor-also called the lease rate or money factor-which is a much lower number. It is used to calculate the interest portion of the monthly lease payment Multiply the lease factor by 24 to figure out the real interest rate.

Example: A lease factor of five is 0.005. So the actual interest rate is 0.005 x 24, or 12%. A salesperson might inflate quotes on monthly payments on a purchase to make a lease look better. Or he/she might draw up a lease using an inflated cap cost-the car price used to calculate the monthly payments. This is higher than the actual price you would pay to buy the car outright A higher cap cost is sometimes 'explained away by saying that it includes finance charges-but in reality it doesn't.

Self-defense: Don't sign a contract on the spot. Take it home, and do the math with a knowledgeable friend.

LEASE- TO-OWN TRAP

If a dealer claims that leasing can save you money even if you ultimately want to own the car, check the residual value-the option-to-purchase price in the lease contract.

Dealers often greatly inflate residual value to lower monthly payments, but at the end of the lease you usually end up paying more than what the car is actually worth.

When your lease is ending, check residual numbers in the Automotive Lease Guide. It is available in most libraries. Check used-car values in car-buying guides, such as National Auto Dealers Association price guides. Your residual value should be no higher than the wholesale or trade-in price. Useful resources...

www.carinfo.com (click on Leasing Secrets Part /1) to learn how to calculate lease payments.

Expert Lease Pro from Chart Software (www.autoleasingsoftware.com) analyzes auto leases for you.

A few weeks after leasing, a customer may get a call from the dealer, asking for more money or saying he needs to sign a new lease because of a mistake in the contract or an unacceptable credit rating. The customer is told to sign a corrected copy, which might cost "just a few dollars extra" per month.

What to do: You are under no legal obligation to accept a new contract. Respond that you will not sign or pay anything without consulting your attorney, and ask the dealer to put his request in writing. In most cases, a dealer cannot legally rescind the contract or repossess