New-vehicle leasing as a financing alternative for consumers has been a customary business practice for years, although its popularity has varied based on interest rates and expected residual values of the vehicles at the end of the respective leases. Leasing typically offers the customer lower monthly payments and provides the dealers with a predictable opportunity to return those customers to the dealerships to purchase or lease another vehicle.
Used-vehicle leasing has also been an alternative for a number of years, but it has not been as popular with customers as new-vehicle leasing. A growing trend among independent dealers who provide “buy-here, pay-here” services for customers is a switch to “lease-here, pay-here” services. Dealers are making this transition for a number of reasons, which include:
- The ability to reduce and/or defer both state and federal taxes
- Cost savings with respect to customer bankruptcy and vehicle repossession
- Exemption from certain regulatory compliance required for financing transactions
A significant potential benefit to leasing vs. financing relates to sales tax. Many states apply sales taxes to each lease payment received rather than requiring the collection of sales tax on the entire taxable amount at the time of the sale. Not only does leasing defer payment of the sales tax over time but it potentially eliminates the loss of the sales tax deduction on repossessions when the related finance contract has been sold to finance company. Dealers should fully understand the sales tax laws of their state prior to changing from financing to leasing. Further, since some customers may move to other states, sales tax filings could be required in the states where customers register their vehicles.
Federal and applicable state income tax savings may be obtained as well, through the deferral of the gross profit that would be realized on a traditional sale and finance transaction. The vehicles remain the property of the dealership and are depreciated over time, using accelerated methods for tax purposes. The use of a related finance company is eliminated, as is the need to book a tax loss on the sale of the lease.
Because the vehicles’ titles remain with the dealership, the dealership can be in a better position when a customer files for bankruptcy or when a vehicle is repossessed. Federal and state regulatory requirements are generally less onerous for leasing transactions than for financing transactions.
Are there any drawbacks? Lease-here dealers can be exposed to lessor vicarious liability. While federal law has now virtually eliminated this risk, some states may still require minimum insurance coverage, and dealers should consider the potential exposure, as well as the cost of the insurance coverage. Dealers should also consider the need for liability coverage to cover product liability lawsuits and claims in the event a lessee fails to maintain the vehicle in proper working order.
Many dealers rely on lines of credit with financial institutions to finance both buy-here and lease-here operations. Lease accounting will significantly change the dealership’s financial statements and tax returns; dealers should ensure that financial covenants are not violated when considering the addition of lease-here to buy-here.
Compared with buy-here operations, lease-here operations can offer benefits; however, dealers should seek advice from knowledgeable CPAs, attorneys and financial advisers before changing from financing to leasing, to determine which operations model works best for them, the applicable sales tax laws and the tax implications of these transactions.
Jim Meade, CPA, CMA, is an Audit Partner at LBMC, PC, and serves on the AutoCPAGroup’s Advisory Board of CPAs. Mr. Meade currently assists dealership clients with assurance services and financial reporting and buy-sell transactions, negotiations with manufacturers, accounting issues consulting, internal audit support and internal control analysis, assistance with arranging financing and dealership profitability analysis. In addition, he is a frequent speaker to dealer and controller groups about these issues. If you would like more information about any of these services, contact Jim at firstname.lastname@example.org.