For many farmers equipment expense represents a major cost to their operation. As equipment cost continues to increase farmers are looking for alternative financing options. Financial institutions and equipment manufactures offer additional financing in the form of equipment leases.
However, the first step a farmer should take is to visit with their tax advisor. “Every situation is unique to each farmer and their tax advisor should be able to provide direction on whether a lease is feasible and/or profitable to their operation,” explained Brian Schrock, Vice President FCS Financial. “A lender can provide the payment amount of a lease so the tax advisor can calculate the net result.”
According to FCS Financial, leasing equipment, vehicles and facilities can be a great way to maximize tax benefits, preserve capital and manage capital expenditures in the most efficient way.
Schrock shared the opportunities and challenges of entering a lease agreement:
Opportunities of Leasing:
• The ability to shorten the write-off period as compared to traditional depreciation schedules
• Allows farmers to update to new technology more often
• Frees up working capital by spreading expenses over multiple years by only paying for what is used
• Can be used to transfer an asset to the next generation for the purchase amount of the lease
• Leased item itself is the only collateral required to secure the lease. Example, land is not required for buildings or bins.
• First payment due at signing and no money down
• Trade in equipment can be applied to first payment
Challenges of Leasing:
• No ownership of equipment
• Trade in equipment value may be claimed as capital gains on taxes
• Lower residual amounts raise the payment amount similar to loan payments compared to a higher residual that lowers the lease payment
• Lease interest rates can be higher than loan rates
• Does not build net worth on a balance sheet
Leasing can also help businesses maximize tax benefits. Schrock explained, “Capital expenditures are generally depreciated under a schedule based upon the property. Normally, a business owner who bought a piece of equipment with, for example, a five-year expected life would depreciate the cost of that equipment on their tax return gradually over those five years.
“There is a unique opportunity leasing offers. By leasing, a business can effectively manage both cash flow and tax benefits during the term of the lease. Under a ‘true lease,’ a business can lease equipment or facilities and write off the lease payments as operating expenses over the term of the lease, reducing taxable income. This type of lease provides the business with level tax deductions in future years.
“It also offers the ability to shorten the write-off period as compared to traditional depreciation schedules. For example, a machine shed can be placed on a 7-year lease. Typically, a machine shed is depreciated over 20 years. By expensing the lease payments over 7 years rather than depreciating over 20 years, the write-off period is greatly reduced with a lease. Typically, true lease structures have a minimum 15 percent purchase option at the end of the lease and offer flexibility at lease end to purchase or return the equipment, or renew the lease.”
However, the current section 179 tax laws just came to a close in November, which allowed a $25,000 initial write off amount. With the New Year approaching and no new laws established Schrock said, “Several proposals have been presented to Congress and many speculate that they will be written prior to year end. If the current Section 179 tax laws don’t change then leasing will provide producers with an option to lease equipment and capture write offs on their taxes. If new tax laws allow a significant depreciable amount similar to what has been available prior to 2014, then leasing won’t be as beneficial.”
Schrock concluded, “Leasing is a way to help mitigate tax liability. Leasing assets for farm use is much different than leasing automobiles. Every farmer’s situation is different and providing a tax advisor with payment options and terms will help in identifying if a lease is the right tool for the operation.”