AgDM newsletter article, April 1997

Machinery leasing - Is it for you?

By William Edwards, Extension Farm Management Specialist, 515.294.6161, wedwards@iastate.edu

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.

Types of Lease

Two general types of lease plans are available.  The major factor that distinguishes these plans is by how they are treated for tax purposes. 

True lease

A true leasecalls 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.

Finance lease

A finance leaseis 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.

Advantages of leasing

Although leasing may not be for everyone, there are several advantages.

Not for everyone

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.

Expense method depreciation

In addition to regular depreciation, you may be eligible for expense method depreciation during the first year.  The IRS has raised the limit on expense method (section 179) depreciation to $18,000 for 1997.  This limit will increase to $25,000 by 2002.  This deduction is available for machinery purchased or leased under a finance lease, but not under a true lease.  So, you may prefer to acquire the machinery by an outright purchase or a financial lease and take full advantage of the early depreciation option.  However, if you buy other property that can also utilize the expense method depreciation, you may have already reached your limit for the year.

Include on the balance sheet

Sometimes leasing is touted as off balance sheet financing.  However, while a true lease is not a loan, it does represent an obligation to pay and a cash flow commitment is incurred.  In addition, the “Farm Financial Standards Task Force” recommends that leases of capital assets be shown on your balance sheet.  The next payment is shown as a current liability.   The discounted present value of the remaining payments is shown as an intermediate liability.  The sum of these two values is then listed under intermediate assets, representing your right to use the machine.  It is not appropriate to value the machine at fair market value or cost value, since you do not actually own it.

Questions to ask

As with any contract, read the fine print and ask questions before signing.  The following provisions should be discussed and understood.

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