by Tamara Scully
Leasing versus buying needed equipment is a complex decision, and is not a simple cost calculation. Factors including cash flow, tax implications, payment structure, age of equipment being considered, type of lease, financing terms and more must be considered. And in every instance, new calculations must be done.
“Farm machinery really is one of the most important things we can talk about. We talk about equipment investment and expenses and how to understand what equipment really is costing you…because this equipment is going to account for a significant portion of your expenses as a farmer,” Brent Gloy of Agriculture Economic Insights (AEI) said. “This is one of the most complex decisions that we can make.”
Decision inertia, where we simply do what we’ve always done, is particularly inadvisable regarding leasing or owning equipment. Changing financial circumstances, changes to the tax law, succession or retirement planning and new technology and equipment advances impact the lease vs. own decision. This decision must be evaluated – and re-evaluated – regularly.
Several calculations are important when deciding whether to lease equipment or purchase outright, David Widmar, also of AEI, said. A decision checklist is an important tool, and should be created each time a decision needs to be made. This can ensure farmers are looking at all of the metrics and weighing the numerous, complex factors which influence the lease vs. own equation.
Consulting your accountant is a vital part of any buying or leasing decisions, Widmar said, as there will always be financial trade-offs with either option. The type of financing being offered, the tax implications of that financing vs. those of an outright purchase, the end of lease terms, the impacts the purchase or lease will have on the farm cash flow and balance sheets, the costs of ownership and how the purchase or lease fits into the overall goals of the farm are all variables in the decision-making process.
The purchase price and loan terms aren’t the only costs of ownership. The cost of repairs, insurance, economic depreciation, interest and taxes are also part of the cost of ownership.
How much it costs to operate this machine, on an hourly basis or on a per-acre basis, or just in total dollars, is the ownership cost, Widmar said, and includes all variables of owning and operating the equipment.
The ownership cost ultimately depends on the salvage value, which is a factor of economic depreciation. But salvage value is unknown until the equipment is either sold or taken out of service.
“There’s some uncertainty about the salvage value, and as the owner of it you have all of that risk,” Gloy said. “What do you think the resale value is going to be of that equipment? How well do you think that residual value is going to hold up?”
When purchasing equipment, the entire cost is paid for up-front. A down payment, plus a typical loan financing the remaining purchase in payments lasting four or five years, means that there is a mismatch between the long lifespan of the equipment and the shorter time period you have in which to pay for it in full.
Ownership can be beneficial in terms of tax planning, as the cost of equipment can be depreciated over the first few years. Tax laws change from year to year, so the environment is not always favorable for depreciation. Ownership also builds equity and provides flexibility in how you utilize the equipment over its lifecycle.
Leasing decreases the down payment needed and frees up working capital, Widmar said, and reduces immediate term debt. But not all leases are the same. There are two types of leases – capital and operating – and the differences are important for accounting and tax purposes.
A capital lease will be treated as a debt for accounting purposes, and any lease with an option to buy at the end of the lease term falls into this category. Capital leases depreciate over time and incur interest expenses.
An operating lease has no ownership transfer and is treated as an operating expense, which will impact net income. What happens if the equipment needs repairs at the end of a lease agreement? What is the expectation of equipment condition upon the lease’s end?
A downside of leasing is end of term agreements. Lease-to-own agreements have a large residual payment due at the end of the lease term, while operating leases typically have limits on the number of hours the equipment can be in use during the term, with penalties for overages.
“Leases are another financial tool” and can be beneficial when used appropriately, in the right situation, Widmar said. The answer as to whether or not a lease is beneficial in any particular situation “will be different across farms.”
Leases are often important tools for beginning farmers, those with cash flow challenges, farms undergoing rapid growth and those planning for succession. The tax climate also plays a role, with leases being more favorable when depreciation is less allowable. The availability of manufacturers’ leasing programs may also influence the decision.
Comparing the terms of an outright purchase, a lease-to-own and a walk-away lease agreement side by side can help with the decision-making process. Chris Steinkamp, AgDirect territory manager, said he encourages farmers to “look at the payment differences across these different options.”
“Financially, cost per hour or cost per acre is important,” Steinkamp said. “It’s not so much how many months out of the year you’re using it.”
In some cases, leasing can allow those with tight cash flow to buy a newer piece of equipment than an outright purchase would allow, Gloy said. So a newer piece of equipment might not financially feasible to purchase, but can be within reach if leased.
Deciding whether to buy or lease isn’t a straightforward decision. With many variables to consider, the decision made today may not apply the next time you have an equipment need. Sometimes, the answer may be to do neither, and to hire a custom operator. Or the decision to buy may include becoming a custom operator, to recoup the most benefit from a purchase.
“When it comes to leasing and owning, you’ve got options,” Steinkamp said. “Know what those options are.”