Equipment leasing: The final frontier
With the reduction of Section 179 expensing and the disappearance of Bonus Depreciation, many farmers and ranchers are reconsidering the approach they take when acquiring assets for use in their business. Given past profitable years and the desire to upgrade machinery, buildings, grain handling structures and other vital farm assets, previous tax law gave favorable treatment for expensing these purchases against income generated on the farm or ranch.
At the end of 2013, Section 179 and Bonus Depreciation either adjusted or went away completely. In the case of Section 179 allowances, the limit was reduced from $500,000 in 2013 to $25,000 for 2014. Additionally, Bonus Depreciation, the ability to deduct 50% of the purchase price of “new” equipment only, has completely disappeared. Producers who have counted on this in the past to offset income may face increasing income tax bills due to lost deductions.
As an alternative to these prior depreciation programs, many producers are exploring the potential tax savings of equipment leasing with their tax advisors. The equipment lease is currently treated like a rental expense. Since the leasing company (the “lessor”) owns the asset and leases it or “rents” it to the lessee, the periodic lease payments may be deductible rental payments to the producer lessee. A qualified tax advisor can assess your individual situation and determine the tax advantages of leasing for your operation.
At the end of the lease, the lessee generally has the right to exercise a fair market value purchase option. At this time, the producer takes actual ownership of the previous leased asset and most likely will depreciate the value of the purchase option over the appropriate depreciable life as determined by the IRS.
Producers can lease equipment acquired from dealerships, private party sales, at auction or through direct distributors of those items. In the case of buildings and grain handling structures, arrangements for pre-funding and interim progress payments can be negotiated to allow coverage of the building costs throughout the construction phase of the project, eliminating the need for the producer to cover these costs out of pocket.
The best advice for anyone considering a lease transaction is to meet with their tax advisor and discuss the potential tax treatment for your particular situation. Next, seek out a leasing company who has experience with farm and ranch equipment leasing. They will be able to provide you with details regarding lease terms, payment flexibility, purchase options and lease funding options. Finally, weigh the cost of equipment upgrades to potential efficiency gains, reduced down-time and production improvement. Acquiring equipment to eliminate tax burden sounds attractive but still creates a financial obligation that must be paid for over time. However, updating machinery by leasing equipment may outweigh looming repair costs and provide potential income tax savings.