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If you acquire a piece of equipment for use in a trade or business, like a forklift or truck, are the payments you make deductible lease payments or do you instead depreciate the cost of the equipment?

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Question:

If you acquire a piece of equipment for use in a trade or business, like a forklift or truck, are the payments you make deductible lease payments or do you instead depreciate the cost of the equipment?

Answer:

When determining the tax treatment of payments made for a piece of equipment, such as a forklift or truck, used in a trade or business, it is crucial to ascertain whether the agreement under which the equipment was acquired constitutes a lease or a conditional sales contract. This distinction is vital because it directly influences whether the payments are deductible as lease payments or whether the cost of the equipment must be depreciated.

If the agreement is identified as a lease, the payments made under this agreement may be deducted as rent. This is supported by the general principle that ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business, including rentals or other payments required for the continued use or possession of property for business purposes, are deductible under Section 162(a)(3) of the Internal Revenue Code.

Conversely, if the agreement is considered a conditional sales contract, the party acquiring the equipment is treated as the outright purchaser. In this scenario, the cost of the equipment is not immediately deductible. Instead, the purchaser must recover the cost through depreciation deductions. The basis for depreciation is the adjusted basis provided in section 1011 for the purpose of determining the gain on the sale or other disposition of such property, as outlined in Subsection 167(c)(1). The depreciation deduction allows for the recovery of the equipment's cost over its useful life, reflecting its exhaustion, wear and tear, or obsolescence.

The determination of whether an agreement is a lease or a conditional sales contract depends on the intent of the parties, as evidenced by their agreement, read in light of the facts and circumstances at the time it was entered into. Factors that may indicate an agreement is a conditional sales contract include:

  • Part of each payment is designated towards an equity interest in the property.
  • Title to the property transfers after a certain number of payments.
  • The total amount paid significantly exceeds the equipment's fair rental value.
  • The agreement includes an option to purchase the equipment at a nominal price.

Therefore, to answer the question, if the agreement for acquiring equipment like a forklift or truck is a lease, the payments are deductible as lease payments. If the agreement is a conditional sales contract, the cost of the equipment must be depreciated over its useful life, according to the applicable depreciation methods and periods specified in the Internal Revenue Code and Treasury Regulations.

Sources:
CCA 200242006
PLR 9303016
IRS FAQ
§ 167. Depreciation
PLR 9246012
§ 179. Election to expense certain depreciable business assets
Publication 946 (2023)

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