BY GREG MERMEL, C.P.A.
The newspapers are full of glum stories about the lagging economy, claiming that consumers are slashing their spending. Turn on the evening television news, and you will see an interview with a woman wringing her hands and agonizing about how with gas at $2.00 a gallon she can’t go visit her family in Kentucky.
My clients, of course, are slightly perverse and counter-cyclical. A half dozen of them have called me in the past few weeks to discuss how they are going to finance their new cars.
And since they all start with the same question, I’ll answer it first.
No.
I don’t care who told you, it’s not true. The mere fact of leasing a car does not make it fully tax deductible, nor does leasing change the percentage of costs that you can write off. That remains determined by mileage (how many miles you drove your car for business, divided by the total number of miles you drive your car that year).
The only way leasing a car can increase the dollar amount of your tax deduction is if it costs you more than owning. And that, in turn, flies in the face of other advice I often give–don’t spend a dollar to save 25 cents in taxes.
Is There A Point in Leasing?
I’m old enough to remember when no reputable lender would make an automobile loan longer than 36 months. Most people who were prospective new car buyers could afford those monthly payments. And more important for the lenders, they wanted to make sure the collateral (that is, the car) would be worth at least as much as the balance on the loan. Back then, most five- or six-year-old cars were pretty much ready for the scrap heap. You counted yourself fortunate if you got to 100,000 miles without major engine problems and the body rusting out.
However, over the last 20 years new cars have become significantly more expensive, even after adjusting for inflation. But they have also become vastly more reliable and long-lived; it is now common to see 10-year-old cars in good physical and mechanical condition. This meant lenders could safely do 48 or 60 month loans, and paying over a longer time partially offset the effect of higher prices.
But not entirely, and for many people, not enough. Enter leasing. You put less money down, and make lower monthly payments. All you are buying is the use of a car for the first (x) months of its life, after which your leasing company has a nice used car to sell. Because the residual value remains with the lessor, they don’t have to make their entire profit on the transaction from you. The monthly payments can be, and almost always are, lower than buying. Of course, after the lease you either start over with another car, or ride the CTA.
Car buyers have the residual value instead of the leasing company. Once the payments end, they drive with no cost of ownership until they finally sell the car or it wears out. You could think of the higher monthly payments on a loan as a form of prepaid rent for the three, five, or eight years that you drive the car after the loan is paid off. For some people this doesn’t matter. They want a new car every three years or so, whether they need it or not, and are willing to pay a premium.
Running the Numbers
If you have the data, comparing mathematically the purchase or a lease of a particular vehicle is fairly easy (at least for me). There is an interest rate implicit in the lease that can be calculated from the value of the new car, its likely residual value at the end of the lease, and the payments. This can easily be compared to the interest rate on a car loan after adjusting for the differing down payments.
What is increasingly difficult is getting a straight answer to two questions: What would you pay for the car if you bought instead of leasing, and what is the leasing company’s expected residual value? The reason should be obvious: leasing companies do not want to encourage these comparisons because the result is almost never favorable to leasing. That bank or car manufacturer’s credit subsidiary makes more money leasing the car than selling it, with one exception–if something catastrophic happens in the used-car market during the term of the lease and the car is not worth its expected residual value.
If one were charitably inclined, one could say some of the higher cost for leasing is a fee to the leasing company for absorbing that risk. But I am not so inclined. For a buyer, that risk is no risk at all, because he’s not selling the car, he’s using it; the car’s utility to the buyer is independent of the car’s market value.
Are You Sure?
Leasing has another aspect that many people miss. How sure are you that you are going to want this exact same car for the next 24 or 36 or 48 months? Better be real sure that you’re not going to have kids or move to London or take up camping or have any other reason you might want a bigger/smaller/more powerful car or none at all. Getting out of a lease before it ends can be very costly. A buyer can always sell his car; even if the price it fetches is less than the loan balance, the difference will be less than a lease termination fee.
If leasing is really the only way you can afford a new car, consider an alternative. The biggest decline in the value of a car comes in the first few years. Take advantage of the longer lives (and longer warranties) that cars now have, and buy yourself a nice, three-year-old car. You know, the one somebody just turned in at the end of his lease.
Are there money or tax questions you would like to see discussed in this column? Let me know, at 2835 N. Sheffield, Suite 311, Chicago, IL 60657, or 773/525-1778 (888/525-1778 outside the Chicago area).
Greg Mermel is a certified public accountant whose clients in the arts range from individual performers to major theatre companies and suppliers. He also sometimes produces theatre.