Tax Benefits of Leasing

Financial economists view the tax benefits of leasing as a complex function of the tax deductions and income associated with rentals, depreciation, and interest attributed to lessors and lessees facing different tax rates. We offer two ways to simplify that complexity using the concept of present value depreciation, which reflects the decline in an asset's value (present value of remaining cash flows) over time. We rely on the insight in Samuelson (1964) that tax rates do not matter if depreciation allowed under tax rules equals present value depreciation. We show that tax benefits of leasing, between a high tax rate lessor and zero tax rate lessee, equal the present value of lessor tax shields on a) the difference between actual tax depreciation and tax-neutral depreciation implied by actual rentals, or b) interest expense associated with a “loan” from the lessor to the lessee created by deferring actual lease rents relative to tax-neutral rents implied by actual tax depreciation