Throughout history there have been difficult questions posed to mankind. Hamlet fretted over "to be or not to be" while for a whole decade sports fans argued if the lite beer was less filing or tasted great. But to those of us who offer financial and tax advice one of the toughest questions is "should I lease or buy this new car?"

There are numerous factors that have to be considered and there is no right answer for everyone. These factors include:

1. the business use percentage of the vehicle
2. the total number of miles driven in the year
3. the tax brackets of the individuals
4. the purchase price of the vehicle
5. the implicit interest rate in the lease vs the purchase

I will attempt to discuss these to give everyone a feel for how these factors interrelate. However, I understand that we all are busy so I will give you all a peak at the ending. The rules of thumb, but I want to extremely stress there are many exceptions, are:

And for those of you who didn’t immediately leave the article after seeing the ending and thought they would stick around a bit more there is a spreadsheet calculator available for free online that does a pretty good job analyzing all of the factors and giving a recommendation. The spreadsheet calculator is by Cherie O’Neil, CPA, PhD at Colorado State University and can be found at WWW.biz.colostate.edu/faculty/cherieo/. Last time I looked the link was on the right side on the web page under the picture of the car. It can be downloaded to your computer.

Non tax Issues:

Now for any of you who are left let’s look at the factors that need to be considered. The first I always stress that rarely are you comparing equal interest rates when looking at the lease vs buy choice. When you buy and you finance the purchase you are given the interest rate in the truth in lending statement. Thus it is very easy to shop around for the best rate and the rate can even be negotiable with the lending institution. When you lease there is no such disclosure. At since it isn’t obvious to the lessee the implicit interest in the lease tends to higher and sometimes significantly higher. Its called the american way. The lease companies can play with the residual payments as well as the lease term to give the appearance of a better deal. The hidden interest usually isn’t a negotiable item but the residual payment usually is.

And if purchase the vehicle for cash what interest rate is implicit. Most would argue that it is your implicit borrowing rate i.e. the rate of interest you borrow for other items. But if you are not a borrower the rate you would use would be the rate you earn on your investments as the cash you used to purchase the car is no longer being invested.

Most leases come with a mileage allowance. This factor is related to the residual value at the end of the lease. If at the end of the lease this mileage is not exceeded the lessee may merely turn in the vehicle and pay a small lease termination fee and be done with the car. He has no asset to sell but his monthly payments are generally lower as he has essentially has sold the car and was able to reduce his monthly lease payment by this hypothetical sale. If the mileage exceeds the allowance an additional amount needs to be paid.

When you purchase you have a larger monthly payment but you get back some or all of this excess amount over a lease payment when you eventually sell the vehicle. And since the timing of these payments and sales happen it different years a present value approach is the only way to truly evaluate your decision.

When a vehicle is used in a trade or business deductions are available to reduce your taxes. If the vehicle is owned by a corporation the deduction is the actual deductions including depreciation or lease payments if leased. If the vehicle is owned by a self employed or an employee the deductions are the greater of 34.5 cents per mile (for 2001) or the actual deductions including depreciation or the lease payments if leased. The cents per mile is now available whether the car is leased or purchased if owned by a noncorporation. The main difference between leasing and purchasing is that in a purchase you depreciate the business portion of the car and claim the business portion of the interest paid on the loan. In a lease you deduct the business portion of the lease payment. If the interest rates implicit in the lease and the loan are the same and the price of the car is the same in both cases the total deductions in both cases would be the same.

However, since too many were writing off Porches and Mercedes, Congress decided to pass the "luxury" automobile rules. Section 280F limits the total depreciation in the first five years of a purchase vehicle under 6000 lbs. to $15,300. If the vehicle is leased the lease deduction is essentially reduced by a lease inclusion amount which is intended to equivalent to the depreciation limitation imposed on luxury purchased vehicles. It is my belief that this is not accomplished very well in the earlier years of a lease and the deduction of the lease is greater in the first couple of years especially when the price of the vehicle increases. Remember the lease payments of identical cars can be different depending on the residual value but the lease inclusion is the same as it is taken from an IRS table.

And overlaying all of the tax factors is the tax bracket of the taxpayer.

The following example is taken from the Journal of Accountancy.

Facts: Self employed

MSRP $41,305 Purchase down payment $250

Your price $37,729.94 Interest rate 8.15%

Marginal tax rate 39% number of loan payments 60

Lease number of payments 60 monthly lease payment $652.65 Downpayment 250 Residual value $10,326.25 lease termination fee 350 Qualified business use 80%

Using the spreadsheet calculator mentioned above the results was that purchasing had a net discounted cash flow advantage of $2,168.29. However by changing the lease to a 48 months and the residual value to 12,391.50 the results were that leasing was an advantage. The monthly payments changed as a result to the length of lease and residual change as well. But you can see the same car can have different results by merely changing a the length of lease and/or the residual value.

In conclusion this is a complicated question that really can’t be answered in full in a newsletter type article nor in a two minute phone call so many of my clients so request. So I encourage you to download the spreadsheet calculator and start putting in the hypothetical facts. You may begin to get a feel for when it is obvious to lease of buy but no one size fits all. And now you can see why I gave away the important ending in the second paragraph.