 The Clarinet BBoard
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Author: Sean.Perrin
Date: 2011-12-09 23:49
I'm just wondering, as a self-employed sole proprietor (musician) would it make sense to lease instruments rather than purchase?
Does anyone here lease their clarinets? If so, why?
I'm not seriously considering it, but seeing as a sole proprietor can write off 100% of a business-based leasing expense, but NOT the full purchase value... does it actually make more sense, in spite of the "extra" expenditure?
Any thoughts?
Founder and host of the Clarineat Podcast: http://www.clarineat.com
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Author: Paul Aviles
Date: 2011-12-10 12:18
Gosh, if you can write off the expense ...... GO FOR IT !!!!
I don't know if students do this as a rule any more but when I was starting out it was a given that you rented for awhile to see what you thought. Many shops would offer the final sale price of that horn discounted by the amount already put forth on rental.
In today's new money thinking I like the idea of writing it off as a business expense. The only problem in the States is that I have never seen a shop do this for top line horns.
................Paul Aviles
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Author: DrewSorensenMusic
Date: 2011-12-10 14:29
As a cruise ship musician, I can and do write off my instrument, reed, etc.. purchases. I don't get that money back in hand, but it brings my yearly earned income down so low I don't pay much in taxes, and I get a refund every year.
Only problem here is that if you sell an instrument, it can be considered taxable income, but that's pennies on the dollar talk.
You're much better off purchasing a great instrument for more money than renting a bad one for less. It will be financially worth your while in the long run.
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Author: Sean.Perrin
Date: 2011-12-10 18:00
I have great pro horns already... but I'm thinking that if I even do want to upgrade, this might be the way to go. Maybe even a way to do an early upgrade!
Maybe it's different in canada, but actually purchasing new equipment is different on your taxes than leasing. Leasing is a 100% business expense whereas, I believe, purchasing is treated as a depreciating business asset, of which only a certain portion can be applied each year, and only for a certain number of years. I'll have to look into it more...
Thanks for the comments!
Founder and host of the Clarineat Podcast: http://www.clarineat.com
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Author: Sean.Perrin
Date: 2011-12-10 18:03
Paul, you don't go through a "shop" to lease... you go through a leasing agency. ANY leasing agency will lease you anything. They purchase it from the store, and you lease it from them. They like it because, in time, they make 8-10 % on the dollar, and you (or I) like it because it can generate thousands in expenses and lower your taxes significantly, or even generate a return. It's win-win, really.
It's actually making a lot of sense to me... I'm considering an upgrade and trying this... why not?
Founder and host of the Clarineat Podcast: http://www.clarineat.com
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Author: Jack Kissinger
Date: 2011-12-10 20:39
Sean, you might want to curb your enthusiasm just a little. Let's suppose that you want to acquire a pair of clarinets that will cost $7,000. Let's also assume that your options are to buy the clarinets outright or to lease them from a leasing company that wants to earn 8%. If you lease, ownership of the clarinets will pass to you after you have made your final payment. Let's also assume that your taxable income before the deduction for your clarinets is $50,000 - $80,000 (putting you in the 22% tax bracket). Note that the clarinets will be classified as Class 8 assets according to the Canadian tax code.
If you lease the clarinets, with no down payment, making payments at the beginning of each year of the lease term, your annual rent will be $2,493 (x 3 payments = $7,479 total). Deducting this at a 22% rate reduces your taxes by $1,645 over the three year term of the lease.
If you purchase the asset outright, you will pay $7,000 for the clarinets. For tax purposes, these will be depreciable (until you have deducted the entire $7,000) using a 20% rate on their declining balance (pain in the fanny, that). Over the first three years, your total depreciation allowance will be $3,416. Deducted at a 22% rate, this reduces your taxes by $752 over the first three years.
So, your hypothetical tax savings for the first three years are ($1,645 - $752 =) $893. But, before you get excited, note that you had to pay the leasing company ($7,479 - $7,000) = $479 in finance charges. That means your actual savings over a three year period is only ($893 - $479 =) $414.
To keep things simple (and because I don't know the rate of return you can realistically earn on invested cash), I have left out present value considerations (except in calculating the lease price). Also note that, while the tax effect of the lease is complete by the third year, you can continue to deduct the cost of the purchased asset into the future. (Again, ignoring present value, by the end of the 7th year, you would be slightly ahead to have purchased.) If you sell the clarinets after three years, you will owe taxes on the entire selling price if you originally leased them. If you purchased them, you will owe taxes on the difference between the selling price and their remaining undepreciated cost.
If your taxable income is less than $41,544, your tax savings will be 15% rather than 22%. That would reduce the advantage to leasing to less than $300 in the above example. Of course, if you anticipate buying a lot more equipment, the benefit from leasing would increase (so you might want to toss in a new bass clarinet, Eb clarinet, a couple of saxes, etc. -- the more you spend, the more you save. Right?)
In your case, particularly if you are currently in the 15% tax bracket but expect your income to move up into the 22% bracket in the near future, delaying the deductions might actually be to your advantage, though the amount of savings probably won't be worth waiting for.
I guess I would have to ask whether the few hundred dollars you are likely to save is worth the hassle.
Best regards,
jnk
Post Edited (2011-12-10 20:48)
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Author: Mark Charette
Date: 2011-12-10 21:00
Jack Kissinger wrote:
However, to complicate the issue, most leasing companies will lease them to you for X years, assuming that you will want new ones at the end of that time. The leasing companies assume a depreciated cost at the end of the period which may be more or less than the market value - you can pay the residual that was agreed upon in the beginning to purchase the item outright, or turn it in. Turning it in early ("I don't really like this ...") is a REALLY expensive proposition should the leasing company even allow it!
It's a complex set of equations at work, and a leasing company will probably not want to work with you since there's no well-established and solid marketplace for used instruments -even with well-established marketplaces such as the automotive sectors leasing companies sometimes bet wrong on residual value and take a bath ... they charge pretty high in the computer market since the value of a computer after 3 years is essentially nil.
There ARE advantages to leasing high-value items, but I don't think a clarinet would cut it.
Also - you will have to maintain insurance with a very low deductible on the clarinet while it's in your possession since the leasing company will want hard cash in their hand should something unforeseen happen to the instrument. That needs to get factored in.
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Author: Sean.Perrin
Date: 2011-12-10 21:48
This was a 2 year term at 52 per 1000, with a 20 percent buyout cost at the end; or new equipment every tow years with a continuation of the lease.
Interesting ideas here... I don't think it's worth it for something as personal as an instrument, but it's an interesting option.
Founder and host of the Clarineat Podcast: http://www.clarineat.com
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Author: Bob Bernardo
Date: 2011-12-11 02:58
I for sure wouldn't. When you lease theres no telly what you will bet even if its a Buffet r-13. They don't play the same so be prepared to make adjustments every time you use a rented horn.
Some of the better stores may offer a lease to own, but usually your credit has to be half decent. They may allow you to pay off a horn over a 12 month period, but thats unusual.
Good luck
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Author: Jack Kissinger
Date: 2011-12-11 05:04
Bob,
The lease Sean is talking about is quite different from the one you are envisioning. In the leasing situation that Sean describes, the lessee (in this case, Sean) would go to a music store of his choice and select an instrument the same way as if he was going to buy it. Instead of buying it, however, he would have a leasing company (really a finance company) buy the instrument and then lease it to him for a specific time period. In substance, the lease is not a short term rental but rather a way of financing the purchase of the instrument. In substance, the transaction is the same as if Sean borrowed money on a note that he will pay back over time and used that money to purchase the clarinet.
Mark,
As you know, leases are contracts and they can vary on a number of parameters. One of those parameters is "Who takes title at the end of the lease." I created a lease for my hypothetical situation where title would pass to the lessee (Sean) because, presumably he would want the use of the instruments he had carefully selected for more than my hypothetical three (or his actual 2) year lease term so he would structure a lease that allowed him to take ownership at little or no additional cost by the end of the lease. You have introduced an alternative scenario and assumed that the title will remain with the lessor and, because the lease is short-term relative to the economic life of the asset, it should have some cash value when the lessor gets it back. Any value the asset is expected to have when the lessor gets it back, reduces the amount the lessor needs to recover from the lease payments and, therefore, reduces those payments -- and Sean's tax benefits. Also, Sean doesn't have the asset at the end unless he chooses to pay the "residual amount." This amount is often a best-estimate of the asset's fair market value but it could just as well be a negotiated (arbitrary) amount agreed on by Sean and the lessor. In this case, you could view the residual amount as a kind of balloon payment at the end of the financing agreement. Except that the lessor doesn't normally want the asset and doesn't want to be left holding the bag. Therefore, the lessor will either set the residual arbitrarily low (in which case it may only have a small effect on Sean's payments) or the lessor will require Sean to guarantee the residual, i.e., if Sean returns the clarinet and the lessor can't sell it for at least the agreed-on residual amount, Sean has to make up the difference. In any case, without actually going through the analysis, it seems to me that a lease like you describe would be less attractive to Sean because it would reduce his tax benefits and leave him without the instrument at the end of its term. In other words, if my lease doesn't give him much benefit (and IMO, it doesn't), no other lease structure is likely too, either.
Sean,
In the case of the lease you describe, it seems to me that the lessor is protecting itself by setting the residual value significantly below expected market value. With normal wear and tear, I would expect (and eBay seems to bear out) that a two-year old professional clarinet will probably sell for closer to 50-60% of its original cost. Thus, under ordinary circumstances, they expect you will exercise your purchase option (and they won't be stuck with a clarinet they have no use for).
To use your lease terms for my $7,000 clarinets, assuming you make your lease payments at the beginning of each lease year (a little easier math than monthly payments and the results are close), your lease payments will be $2,940 per year or $5,880 in total. Assuming you exercise the 20% purchase option, you will pay $1,400 at the end of the lease. Your total payments are thus $7,280. Your tax deductions would total $5,880 and your tax savings (assuming the 22% tax bracket) would be $1,294.
If you purchase the clarinets, your first two years' depreciation deductions will total $2,520 and your tax savings would be $554. The incremental tax savings from leasing in the first two years (the leasing "tax advantage" is thus($1,294 - $554 =) $739 but, because you have to pay $280 more for the instrument under the lease, you net savings is $459. Not bad but, realize that under the purchase option you will have a $4,480 asset on your books for tax depreciation purposes in the third year ($896 in depreciation, $197 tax savings). Under the lease option with purchase at the end, if Canadian tax law works the way I think it would, you will have a $1,400 asset on your books for tax depreciation in the third year ($280 in depreciation, $62 tax benefit).
In its economic substance, as I've said before, a lease like this is essentially equivalent to borrowing on a note to pay for the instrument. While the tax implications are a little different, generally, if you plan to keep your clarinet for several years, the only way leasing will be better than buying is: (1) you have the cash available but can earn (risk-free) more than 5.2% by investing it elsewhere, or (2) you don't have the cash available and 5.2% is a lower interest rate than you'd have to pay to borrow the money using the clarinets as collateral. (Actually, if you have to borrow to buy the clarinets, the tax benefits may make leasing a more attractive alternative than borrowing at a somewhat lower rate and purchasing the clarinet. But this is a quirk of Canadian tax law.)
BTW, in the U.S., the entire cost of most musical instruments can be deducted in total in the year of purchase under Section 179.
Best regards,
jnk
Post updated to correct error in calculations.
Post Edited (2011-12-11 21:29)
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Author: Sean.Perrin
Date: 2011-12-11 18:51
Bob,
A lease is nothing like a "rental," nor is it, in my opinion "financing"... it is a different way of paying for a purchase, so that you may expense the full value.
Jack,
I really appreciate your insight, and I will reply later more fully when I have more time. The only thing that's missing in your equation is the time value of money. It's better to pay 7314 over two years, that to drop 7000 at the beginning of the same period, because the money can be put to other uses. At the very least it could accumulate 3% interest in a savings account.
Just a thought!
:)
Founder and host of the Clarineat Podcast: http://www.clarineat.com
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Author: DrewSorensenMusic
Date: 2011-12-11 19:59
Jack, if you need some work next March/April, let me know .
I know quite a bit less than those posting above, but I just wanted to reply to a post above. As I understand it, upon purchase, assuming that you can consider music your business, you can write off an instrument purchase in one of two ways. This is most commonly like a company purchasing a computer or company vehicle.
Way 1.) You can write it off completely for the the year purchased. If you ever sell said instrument, you must consider it as income for the year it is sold. This is an easy way for me to understand, and makes sense for my personal finances.
Way 2.) You can write it off yearly, as a depriciation of value. I don't know if I'm getting the terms right, and I'm not completely familiar to it, but you alluded to it earlier. Much like company vehicles, your purchase is considered income, and the depriciation of the purchase is what you can write off. Example, if a company purchases a car for $10,000, and could next year sell it for $8,000, then it is possible to write off $2,000 as the depriciation of the instrument while retaining vehicle. If the company sells the purchase at $7,500 in the next year, you can only write off $500 in that year, since you already have written off $2,000 the previous year. This may work very well for new instruments, if you'd like to spread your tax adjustments over multiple years, but if you buy used, expecially if instruments retain their value, I do not believe it makes much sense. Also, it may be difficult to acquire the current worth of an instrument in the market.
Kind Regards
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Author: Jack Kissinger
Date: 2011-12-12 01:55
Drew,
What you say is true in the U.S. but not in Canada, where Sean is. Sean's only option is 20% declining balance depreciation. (Class 8 equipment, per my earlier post.) Unlike the U.S., where I believe the limit is $500,000, in Canada, immediate writeoff is only available for equipment costing less than $200.
Sean wrote:
"The only thing that's missing in your equation is the time value of money."
Yes, I stipulated this in my original post. Actually, I've also assumed away risk. (I've also assumed ownership costs would be the same under both options because you, the lessee, will incur them whether you choose to lease or buy. However, as Mark points out, some costs such as insurance might actually be higher under the lease option if the lessor requires, e.g., a more comprehensive insurance policy than you would otherwise obtain.) I ignored time value primarily to simplify the calculations. However, with a short time period an a relatively low interest rate, the interest effect is relatively small.
"It's better to pay 7314 over two years, than to drop 7000 at the beginning of the same period, because the money can be put to other uses."
Certainly true if you don't have the $7,000 available. Also true, if you have viable investment alternatives. However, common sense would suggest that borrowing at 5.2% to invest at 3% will not be a winning proposition. Assuming a 3% return (which is, BTW, considerably higher than banks around here are paying), the present value of the payments under the lease is $7,114. That means, tax consideration aside, you are $114 better off purchasing for cash. On the other hand, assuming 3%, the present value of your tax savings (lease vs. buy) for the first two years is $648. So, taking time value into account (with a two-year horizon), you are better off by $534. Note that if your income only puts you in the 15% tax bracket, the benefit is considerably smaller. Also, because subsequent years favor the purchase option, increasing the period under consideration reduces the net advantage of leasing though, for someone starting out, the effects three or four years down the road are probably not as important as the immediate effect.
Conclusion: If I understand the tax laws correctly and if my assumptions are reasonable and my calculations are correct, IN CANADA, there are (moderate) financial benefits to a lease such as Sean describes, relative to a purchase.
Best regards,
jnk
Post Edited (2011-12-12 01:57)
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