Leasing Like-New Large Iron
One recent enticement that some dealers are offering to move like-new machinery off their lots is leases. Though leasing used equipment is more common in the construction industry, the practice has been a rarity in agriculture. The idea certainly deserves scrutiny if you are looking to minimize debt.
Of course, there is also a considerable financial windfall in leasing like-new equipment. You can get into a lease of a large low-hour machine at a quarter to a third of the cost of new.
The rules of leasing hold true whether that iron is new or used, says Tina Barrett. “It’s important you consider the pros and cons of this decision and that you consider what effect lease vs. purchase decisions will have on the tax return,” she says.
Reducing debt (by leasing machinery) certainly can improve the debt-to-asset ratio for a farm that has equity in assets. “We also see improvement in the current ratio and working capital of the operation by removing that current debt from the balance sheet. Some lending institutions will include the upcoming lease payment as a current debt, so this may depend on the individual,” says Barrett, who is a University of Nebraska economist and executive director of the Nebraska Farm Business Inc.
Leasing also keeps you from having an asset that depreciates. “One argument that is often made in the case for a lease is that you don’t see that depreciation because you don’t own the asset. On the other hand, by not owning, you will never build equity in the asset,” Barrett says.
A lease can also lower payments and money required up front. Compared with the 10% to 20% down payment required on an installment loan, leasing generally requires only the first two monthly payments, which are calculated by the lender based on an assumption of how much the equipment will be worth at the end of the lease. That figure, called the residual value, is subtracted from the retail price, and the remainder is spread over the length of the lease term in monthly payments that tend to be generally lower than those on an installment loan.
Most financial institutions that furnish equipment with a lease promote tax savings as the main reason you should lease. However, Barrett says, “as a tax preparer, I list taxes as the top con.”
Tax law certainly allows that leasing of farm assets is an “ordinary and necessary business expense,” she explains.
It also clearly defines what is not considered a lease but rather a conditional sales contract (often called an equipment finance contract, or EFC) as defined in the IRS publication.
“In the leases I see, there are many factors that trip the IRS rules. The most common is a lease that has a stated or imputed interest value or does not have a true fair-market value buyout schedule in the end,” Barrett explains. “In simpler terms, a true lease will not have an equal payment as the buyout, there won’t be a stated interest rate, and you won’t gain any equity in the asset.”
This is why Barrett encourages you to show the lease agreement to your accountant so you both can determine how it will be handled from a tax perspective.
Beyond tax consideration, the main difference between a true lease and an EFC is that with a true lease, you make payments for a set period of time (often two to five years). At the end of the contract, you may walk away from equipment or have the option to purchase it for a percentage (often 10%) of the original finance amount.
An EFC has a similar payment schedule to a true lease but is treated as a conditional sale contract by the IRS.
This means you are considered the owner of the machine, so that machine is placed on the farm’s depreciation schedule. Payments made to the lease company with an EFC must be divided into interest and principal, with only the interest portion being tax deductible. Also, since the EFC is not being taxed as a true lease, the final buyout price can be quite variable, depending on the length of the lease and size of the payment.
There is a potential price windfall available due to equipment leasing, John Schofield of Claas points out. “The other side that leasing presents is the opportunity for you to get a good deal on leased equipment that has been turned back in,” he says. “Leasing has become a bigger trend of late, because you can get some really good deals on lease returns, as dealers and manufacturers are trying to reduce used machinery inventories.”
Find an extensive website devoted to leasing farm equipment at AgLease101.org.