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Do the Costs of a Lease Here-Pay Here Model Outweigh the Benefits?

Posted 5:00 AM by

Note: This article originally appeared in The Showroom.

While Buy Here-Pay Here (BHPH) owners are familiar with the benefits of the Lease Here-Pay Here (LHPH) model, many do not take the leap. Others may attempt it but fail to launch a successful LHPH operation.

Understanding the pitfalls of a LHPH model will equip decision makers with the information necessary to decide whether the switch to a LHPH operation is right for them.

What Are the Benefits?

One of the largest benefits of a LHPH model is improved cash flow and liquidity through the deferral of sales tax payments. In a BHPH model, sales tax is remitted for the entire sale price upfront. But in most states, sales tax related to a lease is only assessed on the payment stream from the customer. Additionally, initial customer payments can be collected as non-taxable refundable security deposits.

LHPH owners can benefit from deferred federal and state income taxes through the deferral of the gross profit realized on a traditional sale and finance transaction. BHPH transactions typically result in a sale of a vehicle from the dealership at significant gross margin. BHPH operators often offset the original gross profit generated by selling the installment contract – at a discount – to a related finance company (RFC). Because LHPH transactions typically do not generate a sales transaction, there is no gain to be recognized. Without the need to sell contracts to the RFC, LHPH models can also eliminate the need for the two-company structure, thereby simplifying financial reporting. Furthermore, with a LHPH model, vehicles remain the property of the dealership and are depreciated over time using accelerated depreciation methods that can result in a reduction of initial tax liability.    

Many LHPH operators also enjoy additional benefits, such as better bankruptcy protections and less restrictive regulations. But the question remains: With these benefits, should BHPH owners make the switch to a LHPH model?

Challenges to Overcome

Often, the largest hurdle in making the switch to a LHPH model is related to the additional resources needed to administer a successful and compliant LHPH operation. Sales tax filings are more complex and require more human capital to ensure they are compliant. Additional insurance coverage may also be warranted for LHPH operations.

Turnkey document management systems and accounting solutions for LHPH operations continue to be a challenge for those contemplating the switch. Typically, due to the additional tracking, compliance and reporting requirements, a BHPH software solution does not meet the needs of a LHPH operation.   

Many BHPH dealers rely on lines of credit with financial institutions to finance their operations. Lease accounting can significantly change the financial statements, which can affect compliance with covenants and borrowing capacity. Lenders may also require some upfront education on the leasing program and its feasibility prior to making the switch.

It is important to note that the lease terms established will determine the appropriate accounting methods used for sales tax, income tax and financial statement reporting. Variables such as the age and value of the vehicle at the time of sale, the number of lease payments, the amount of each payment and any residual payments due at the end of the lease will all factor into determining the accounting method used. A detailed discussion of accounting methods is beyond the scope of this article, but it is suffice to say that careful planning upfront is necessary to ensure that the desired outcome is achieved.

What to Consider

Starting a LHPH operation can be difficult, but if the climate is right in your state, making the switch to a LHPH model can enhance the cash flows of your company. Owners should consider the significant upfront cost associated with designing a leasing operation. They should also consider the additional costs and human capital necessary to support the additional ongoing compliance, as well as the tracking and reporting burdens unique to a LHPH operation.

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As one of the top 60 CPA firms in the nation, Katz, Sapper & Miller has earned a reputation as a leader in the areas of accounting, tax, and consulting services. We are consistently named one of the “Best of the Best” accounting firms in the nation by INSIDE Public Accounting magazine. Learn more

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