Forage 2017: Key to an Equipment Purchase or Lease is Research
April 25, 2017
Machinery and equipment are a major expense for agricultural companies, usually coming in second behind the cost of land. The goal of having the right equipment to reduce time, labor and wasted materials makes it worth considering the different options available for acquiring ag equipment.
With four basic strategies–buying equipment outright, leasing equipment, renting equipment or custom hiring equipment–it's the accounting numbers that need to work, according to Tim VanDam, at Churchill Equipment, in Manhattan, Mont. "Talk to your accountant first," VanDam said.
Leasing farm equipment has become a viable option in recent years, in part because of lower farm income and stricter lending requirements. While a purchase with cash or a conventional loan is still the most common, according to VanDam, the high cost of equipment makes it worth looking at the economics of leasing versus buying.
Pros and Cons of Leasing
Leasing equipment typically offers a producer a lower payment than a conventional loan, because there is no equity in the equipment. It also allows the producer to use operating capital instead of investment capital. Payment schedules can be set up around cash flow periods. This also allows for less liability on the balance sheet. And on taxes, lease payments are considered production expenses, and in most cases, can be written off.
"It allows a guy to know exactly what his cash flow is going to be for a set time-period," said Ken Spencer, with 4 Rivers Equipment, out of Cheyenne, Wyo. "It really depends on a [producer's] needs."
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For those trading off equipment on a regular basis, leasing offers lower payments, less up-front cost and the ability to take advantage of new equipment technologies. Some new producers and farmers take the leasing route because of the high down payment on a purchase loan. This could be a pro or a con on tax day.
"The financial statement does not show an asset, only an expense," VanDam said, so it's important to assess the financial picture. "With a purchase, you have depreciation. But a lease can have an expense write off," he added, emphasizing the importance of talking to an accountant.
Those leasing also can take advantage of warranties, with the newer equipment. But not all leases are created equal, and VanDam points out that the producer may still be responsible for basic, or in some cases, all maintenance. And a lease, similar to a car lease, has limits of use. "Tractor leases typically have different categories, for example 250 hours versus 500, and if you go over hours, there is an extra charge," VanDam said.
"The cost of a lease is based on hours for the lease, but most producers know exactly how many hours, so it's not been an issue," Spencer added.
Most equipment manufacturers and some independent companies offer two general types of lease options. Tax purpose is what sets an operating lease and a finance lease apart.
The operating lease gives the producer the option of purchasing the equipment, after a series of payments, over a set amount of years, has been made. The purchase price may be set at lease signing, or may depend on the condition and hours used at the end of the lease. VanDam called this a "true lease," not a rent-to-own. "The financial statement does not show up as an asset, only an expense," he said.
A finance lease is treated as a conditional sales contract by the IRS, so basically the buyer is still the owner. Finance leases are set up with a balloon payment at the end, and the owner has the option to make it, and retain ownership, or return it, similar to a rent-to-own.
Pros and Cons of Buying
Those taking the purchase option have the trade-in value and equity, and the equipment can be sold at the owner's discretion. It's important to remember, leasing companies are in business to make money. Typically, an outright purchase in the long run costs less. This is especially true for machinery that will be owned for five to ten years or more.
"When you buy, you end up with an asset; a piece of equipment that you own and can use as collateral or trade in," VanDam points out. "On a lease, you are just paying for the use."
Buying equipment also eliminates any usage issues and the value of an equipment purchase can be depreciated over time, which increases the asset value on the balance sheet. But maintenance costs should also be considered. While a new piece of equipment may be under warranty for the initial years of ownership, the maintenance burden can be costly for used equipment, or after the warranty is gone. Depreciation, the cost resulting from wear and age, along with maintenance costs of equipment, can be assessed in a spreadsheet offered through the University of Nebraska-Lincoln (UNL) at https://www.extension.iastate.edu/agdm/crops/html/a3-29.html
Purchasing equipment is a huge expense, and should not be taken lightly. With a little research, producers can crunch the numbers with their accountants to make the best decision, considering all factors. "We have not seen much of a rise in leases in this area," VanDam said, but he can see where it could have advantages. "It ultimately depends on the goals of the grower."
Charlie Pipal, with Manhattan Bank, in Montana, echoes VanDam, saying that sometimes it's the difference between a family versus a corporate farm. "It can depend on your level of usage," he said, pointing out that typically the family farm sticks to purchasing, but a corporate farm may have a different take on the lease versus purchase, depending on depreciation and usage. "It's probably more of an accounting question," Pipal says.
Software spreadsheets, designed to help look at the numbers, are available at http://www.montana.edu/softwaredownloads/machinerydownloads.html. The Excel sheets include a number of valuable tools, including:
Lease versus Purchase: Looks at three economic considerations for accomplishing a particular task, outright purchase, straight lease, or a lease with an option to buy, and renting. The net present value of these options are compared to determine the lowest cost option.
Machinery Cost Custom Rates Breakeven Analysis: Calculates the cost of owning and operating machinery for one powered piece of equipment and up to two pulled implements. It also calculates the break-even acreage a producer must have in order to own a piece of machinery and the custom rate a producer would charge if he were to use a piece of machinery to custom farm for someone else.
Single Machine Cost Estimate: Calculates the cost to own and operate one piece of machinery. Can be any pulled implement or powered equipment.
Trucks: Calculates the number of hours of use for individual trucks given the way they are used on a particular operation.
UNL offers some questions to consider before signing a leasing agreement:
- Who is responsible for maintenance and repairs? Clarify who is responsible for insuring the leased equipment, as well.
- What are the purchase option terms at the end of the lease? How will the buy-out price be determined if it is not specified in the contract? Are there adjustments for wear and tear?
- Is it possible to terminate the lease early, if not satisfied? Often there are penalties for doing so. There may also be extra charges for high usage rates.
- What is the timing and frequency of payments? Does this match your cash flow pattern? Can these be modified? When is the first payment due? Often the first payment is due when the machine is delivered or placed in service.
- Does the lease meet the requirements to be taxed as an operating lease, or will it be considered as a finance lease by the IRS? Either choice could be preferred, depending on your tax situation.
- Compare each financing option by laying out the cash payments side by side over the life of the lease or the loan. Estimate the tax savings for each one, and then compare the after-tax cost of each option. AgDM Information File A3-21, Acquiring Farm Machinery Services (http://www.extension.iastate.edu/AGDm/crops/html/a3-21.html) can be used to make this comparison.
- Make your decision based on total after-tax cost as well as near-term cash flow requirements.
Beginning Farmers also offers a list of links, including financial companies leasing agriculture equipment. http://www.beginningfarmers.org/farm-equipment-leasing-resources/