Equipment is the lifeblood of any farming operation. Luckily, there are many different ways for farmers to obtain the machinery they need, with an operating lease and purchasing being two of the most popular options. But which option is right for you? There are pros and cons associated with each route and here we take a look at just a few of them.
Pros for operating leases
Less cost. You can acquire the equipment you need with little to no initial investment. Once the lease begins, your payments will most likely be lower than they would be if you were purchasing the equipment. These are positive things if cash flow is a current concern.
Balance sheet bonus: an operating equipment lease does not show up on your balance sheet and consequent leases do not impact your balance sheet ratio.
Flexibility: you enter into the lease, typically for three to five years, and when it ends, you can upgrade and have access to the most current technology.
Cons for operating leases
No Equity: with a lease, you are not building equity and won’t have the option to sell and receive any of your money back when you done using the equipment.
Limitations: often, the lease will limit the number of hours/miles you can use the equipment and you could be penalized when the lease is up for using it more than contractually permitted.
Commitment: what if the equipment you have leased no longer serves its purpose on the farm? Depending on the terms of your lease, you could be stuck making the payments until the lease is up. Even if an option to cancel the lease is in place, you could be facing large termination fees to do so.
Pros to buying
You own it: with each payment you could build equity, which looks good on a balance sheet. Owning opens the doors to other financial gains down the line. For example, selling the equipment when it is no longer needed and recouping some of your investment or using it as collateral against other loans would be options.
Service as needed: you won’t have to follow a lease company’s service schedule and can maintain the machine as you see fit. Needed repairs can be made immediately.
Long term relationship: if you are investing in a piece of equipment that will be a mainstay on the farm, purchasing is the way to go. There are fewer boundaries than leasing it, and you have the peace of mind that it’s there to stay.
Cons to buying
Upfront funds: putting the money down that is needed up front can be bothersome. Even with financing in place, you could be looking at needing 10% to 20% as a down payment.
Cash flow impact: while the first year depreciation (Section 179 or potential 50% bonus depreciation) is a pro to buying, subsequent years could create a cash flow pinch. That is, depreciation will primarily be claimed in the first year of ownership and depreciation amounts are not available in subsequent years to reduce taxes. Thus if you finance equipment, in the subsequent years you will be paying on the loan and may also need cash to pay for increased taxes (due to less depreciation expense). You’ll want to budget cash flow accordingly.
Old equipment: if a new way of performing a certain farm task comes to pass, or new equipment/technology hits the market, you could be stuck working with an aging piece of machinery. Sure, you can sell it and upgrade to something new, but will the timing be right for maximum return on investment? Also be aware that selling a piece of depreciated equipment will generate depreciation recapture at ordinary tax rates and not capital gain rates.
The above lists don’t even begin to touch on how tax benefits play into each option. While we don’t have enough space to cover all the elements, here are some general key points to consider.
- Consider Section 179 expense or bonus depreciation, especially for higher tax brackets. Remember Ohio does not allow for full accelerated depreciation (179/Bonus) benefits.
- You’ll want to see how the Ohio Small Business Deduction (75% of first $250,000 in pass-through or schedule C or F income) will come into play for you precise situation.
- You’ll want to maximize the Domestic Production Activities Deduction (DPAD)
- Make sure to fully maximize fuel tax credits.
- Plan for potential section 1411 tax impact (Net Investment Income Tax (NIIT) of 3.8% to fund the Affordable Care Act).
Partnering with an accounting firm with experience in Agribusiness will be your best bet when it comes to making decisions about how to obtain equipment. And, whether you lease or buy, an accountant can help you reap the most tax benefits once you make the equipment a part of your operation.
Robert has been with Holbrook & Manter since 1979. His areas of expertise include agribusiness and encompasses corporate strategy, corporate finance, business planning, personal financial planning, corporate tax planning, compliance as well as estate and trust planning. Robert works with a variety of farmers and other agribusiness professionals, including those that have enjoyed long-term success and those who have decided to start new ventures. Robert can be reached at (614) 494-5300 or HolbrookManter.com. Holbrook & Manter originated in 1919 and has offices in Columbus, Dublin, Marion and Marysville.