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Leasing vs. buying machinery
Due to high commodity prices and accelerated depreciation, leasing as an option to obtaining iron has been on the back burner. But $5 corn and the threat to greatly reduce, if not eliminate, accelerated depreciation by Congress is making leasing more attractive, particularly if you are looking to free up capital for other investments.
The best answer for how to finance a purchase is to work through your own details and reach a well-considered best choice. It should reflect your farm’s current situation, history, and forecast. “Leasing is an individual decision,” says Larry Gearhardt, director of tax schools for farm advisers at Ohio State University.
That said, there are some indicators of a shift in the market.
In midsummer, Gearhardt experienced two unusual cold calls encouraging him to lease some equipment.
“That’s the first time I’ve ever gotten calls from leasing companies saying, ‘Check this out, now’s a good time to lease some equipment,’ ” he recalls. “The people who are leasing equipment must be looking for business.”
In his opinion, he suspects that leasing companies may be under pressure due to current very generous expense and depreciation limits. “If you’re in the grain industry, income has been very good over the last several years. We have very generous Section 179 expensing deductions and very high depreciation allowances. I have a feeling that all of those factors, taken together, are leading people to buy equipment rather than to lease equipment,” he says.
In August, Gearhardt participated in a conference for the Land Grant Universities Tax Education Foundation. Directors there were editing the manual for upcoming tax schools in early 2014. For example, they compared the choice to purchase or lease a $100,000 tractor over a 10-year period.
$1,500 more to lease
The result was unexpected. Assuming other factors were the same, over the 10 years, it only cost $1,500 more to lease the tractor than it did to purchase the tractor.
“I thought it was uncanny that there was only a $1,500 difference between the lease and the purchase. Maybe that’s why we’re seeing more purchases,” Gearhardt says. “The amount of money you spend is almost the same; it’s just when it gets done and when you can take the deductions.”
Generally, if the money is available, it’s easier to purchase than to lease. Ownership enables you to take advantage of the Section 179 provision for accelerated depreciation and the separate bonus depreciation option. If the money isn’t available today but the purchase is really important and urgent, then a lease may be the better choice. End cost will be nearly the same, but the initial expense is much less, he says.
Word of caution
Each machinery purchase option – leasing, buying, renting, or hiring custom help – has advantages and disadvantages compared to the others, says Kevin Dhuyvetter of Kansas State University.
Factors to consider – along with tax implications – are loan/lease terms, rental/custom hire rates, size of operation, and timelines. The greater the value involved, the greater the attention needed to the details and implications.
For instance, the terms of an arrangement need to be well understood. For the IRS, a finance lease is treated as a conditional sales contract or, essentially, an installment loan. On the other hand, an operating lease, or a true lease, leaves real ownership in the hands of the leasing company until the last payment is made.
As the lessee, you want the number of hours actually put onto the machine to be close to whatever was written into the contract at the beginning. At the outset of negotiations, an attractive low lease payment rate may be hiding an unrealistic projection for annual hours of use, followed by serious discounting later.
As for taxes influencing the choice of whether to buy or lease, Dhuyvetter says the goal should be to try to pay the lowest rate possible rather than no taxes.
“Leasing is just another way of financing equipment. There’s not a huge advantage or disadvantage; it’s just different,” Dhuyvetter says.
However, the two methods of financing equipment have different tax ramifications. As a general rule for managing a high tax liability, buying equipment will be preferred over leasing.
Leasing can be a way to finance a new building, and sometimes it is more attractive to lease a building than to purchase.
“You might be able to effectively write them off faster with lease payments than you can depreciate them, because buildings have to be depreciated over a long time period,” Dhuyvetter says.
The specific rules vary by building type, so it is important to consult with your tax adviser about what is, or is not, available.
In another situation, a farm may need multiple major acquisitions in one year. The first could be a purchase that uses the full rapid depreciation option. There might be some advantage in leasing the next piece.
“That maybe gives you a little bit more tax flexibility,” Dhuyvetter says.
Fresh eyes needed
Renting and perhaps hiring custom operators are other useful options. Ultimately, decisions for financing are influenced by factors that defy manual calculation.
Gearhardt and Dhuyvetter point out that a method of estimating machinery costs over an extended time is vital to making a decision and not something to try to do without a calculator and an adviser who’s got a fresh set of eyes.
The University of Illinois Farmdoc website contains excellent software for analyzing lease vs. purchase decisions. Go to farmdoc.illinois.edu and look under FAST tools to find downloadable programs.
Kansas State doesn’t have a lease vs. buy calculator, but its website has a publication that discusses the topic. It also offers calculators (OwnTractor, OwnSpray, OwnCombine) that can be used to calculate ownership costs per hour of use, which can then be compared to lease rates and terms.
“We sometimes forget to think about possible outcomes. That’s where a tax consultant or tax adviser can help,” Dhuyvetter says. “Get another set of eyes to help think through potential unintended consequences of the decisions.”