Machinery leasing: Is it for you?
While the vast majority of farm machinery is still acquired for cash or with a conventional loan, leasing is also a popular choice. Leasing plans offer a large degree of flexibility of payment terms. Both farm machinery manufacturers and independent companies offer lease opportunities.
Two general types of lease plans are available. The major factor that distinguishes these plans is by how they are treated for tax purposes.
A true lease calls for a series of regular payments, usually annual or semi-annual, for a period of years. At the end of the lease period, you have the option of purchasing the machine (at fair market value). Alternatively, the machine can be returned to the dealer or lease company, or the lease can be extended. The lease payments are reported as ordinary expenses on your tax return. If the purchase option is exercised, the machine is placed on your depreciation schedule with a basis equal to the purchase price.
A finance lease is treated as a conditional sales contract by the IRS. You are considered to be the owner of the machine so it's put on your depreciation schedule. Payments made to the lease company must be divided into interest and principal, with the interest being tax deductible. Many finance leases are essentially loans with balloon payments after three to five years. The difference is that at the end of the lease period, you have the choice to either return the machine to the dealer (and give up ownership), or make the balloon payment (and take ownership). Since the finance lease is not taxed as a true lease, the final buy-out price (balloon payment) can be quite variable, depending on the length of the lease and the size of the payments.
Although leasing may not be for everyone, there are several advantages.
Lower payments, compared to most conventional loans, is the most significant advantage of leasing.
Of course one reason the payments are lower is that you are building little or no equity in the machine. At the end of the lease period you have nothing except the right to exercise the purchase option.
Machinery leasing utilizes operating capital instead of investment capital. Payment schedules can be matched to periods of high cash flow. Cash requirements for machinery are constant and known in advance. This is particularly beneficial for high volume, low equity operators who can't afford large capital outlays at a point in time.
If you routinely trade major machinery items every few years, you will find that leasing generally offers lower payments than the payments on a loan used to purchase the machine.
If you are near retirement, you may prefer to lease equipment so that it can be easily liquidated in a few years.
Leasing also offers you the chance to try out a particular machine without buying it.
Lease companies are in business to earn a return on their capital. If you have enough money to purchase machinery outright, you will usually spend less in the long run. This is especially true for machinery that will be owned for five to ten years or more. In addition, you build equity through ownership.