Profit Pointers: The Leverage of a Lease

Profit Pointers: The Leverage of a Lease

A lease helps conserve capital and keep cash flowing

Leasing is getting more attention as a way to build working capital and maintain cash flow. Lower profit margins, coupled with weaker tax incentives, could mean equipment dealers will offer lease structures to better match customer needs.  

"There's been a lot of new equipment purchased the last five years, often just to avoid paying taxes," says Charles Brown, Iowa State farm management specialist.

"The accounting treatment of the leases you consider is very important," says Teresa Garside, John Deere Financial. "They do impact your business."

Last year the federal government allowed $500,000 in write-offs under Section 179; this year it's $25,000. Last year a farmer could write off half the cost of a new asset under bonus depreciation; that's gone now. Congress also put in place an investment cap of $200,000 for 2014, instead of the $2 million cap in 2013.

As a result, farmers will lose some incentive to expense asset purchases to cut income taxes for 2014, unless the laws change. That's a real possibility as Congress is poised to reinstate some or all of last year's incentives. In April the U.S. Senate Finance Committee considered a two-year extension of Section 179 levels, where the top amount to expense would return to $500,000 and the phaseout threshold would be set at $2 million.

Related: Making the Case for Section 179

The high depreciation amounts under Section 179 and bonus depreciation definitely stimulated business for equipment makers from 2010 to 2013, says Brown. "A lot of farmers I know don't have a good reason to buy machinery today other than tax reasons," he adds. "Legislators may need to do something if they want to keep the economy stimulated.

"That probably will happen, but we don't know to what level or when," he adds. "It probably won't happen until late fall when people have already made those purchase decisions." Go to www.section179.org for legislative updates.

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But even if depreciation rules return to 2013 levels, a lease still offers benefits. "With the lease expense, you write it off each year, and you don't have to worry about depreciation," says Brown. Plus, banks may be less willing to offer funding if a big liability is on your balance sheet.

Cost conscious
"If you're becoming more cost-conscious, oftentimes a lease structure will be more cost effective over purchase or installment note," says Teresa Garside, director of market development for ag and turf at John Deere Financial.

A lease will require an advance payment, but often it will be less than a down payment on a purchase, she adds.

Lower payments help you improve cash flow and free up capital for other areas of your operation. Perhaps you need additional capital for expansion, such as renting more acres. With an equipment lease, you can manage those extra acres in tandem and not invest in a major purchase that could wind up underused if those acres go away.

Some producers use leasing as a retirement strategy or as a means to bring in other members of the family.

If you're on the fence, ask yourself these questions. First, how long do you need the equipment? If using it a long time, purchasing may be the right call. But for the lowest payment or cost per hour, leasing may be your best bet.

Are you interested in transferring risk? With a lease, the risk stays with the leasing company. A lease has flexibility with hours and terms, and should be structured based on a producer's needs. A finance lease builds equity, while an operating lease improves cash flow and can reduce cost per hour or per acre. 

"There's a lot of flexibility here," says Garside. "Determining your annual hours of use and the term you prefer will help establish your lease payment."

Operating leases are short term — usually shorter than the life of the asset.

"The intent of an operating lease is that you intend to operate the machinery with no expectation to buy the equipment at lease maturity," says Garside. "They will often have a higher purchase option, which gives you a lower payment. So from an accounting perspective, you can treat it like an expense."

A finance lease, in contrast, is longer term with higher payments and a lower purchase option, which builds equity in the machine while leasing. "We do have producers who use the finance lease strategically because they want to build equity and intend to buy the machine at the end of the lease," says Garside. "It's a way for them to get into the equipment with a lower up-front payment."

What happens at lease maturity? You can renew the lease, rent or buy the equipment with cash or finance on installment, or simply return equipment.

Contact your tax accountant, Garside suggests. "They can be an important resource in tax and equipment acquisition strategies. But be sure you are asking these questions and not just defaulting to the way you've always done it."

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