December 28, 2020
When searching for a new tractor for planting, a combine for harvest or even a new hog-finishing barn, sometimes the upfront cost can seem overwhelming. However, there are alternative financing options that can free up cash while providing for the next generation.
One of those financing opportunities is leasing, says John Edgington, senior relationship manager at CoBank. “Every business should consider leasing as part of their long-term financing planning toolkit,” he says.
Farm Credit Leasing, a wholly owned subsidiary of CoBank, works in partnership with the Farm Credit Association to offer lease options. Nationwide, it manages more than $4.8 billion in lease assets, with more than 16,000 customers.
Edgington says no longer are farmers worrying about just “death and taxes.” Now a pandemic can affect farm stability. “A lease can provide additional knowns to control part of the future,” he says.
Break down a lease
A lease is simply an agreement between the owner of the asset referred to as the lessor and a customer referred to as the lessee, to pay for the use of an asset for a specific amount of time, Edgington explained during a recent North Dakota Livestock Alliance webinar.
Duration of a lease depends on the asset. Some farm leases are as short as 24 months, while others extend to 12 years.
For farmers and ranchers, there are a wide range of items that qualify for a lease, including farm machinery, irrigation equipment, grain dryers and handling equipment, animal protein production equipment, greenhouse and winery equipment, and solar and transportation assets such as trucks and over-the-road tractor-trailers. Leases also can be written for farm buildings, including livestock and machine shops.
“At the end of the lease, there is an option to either return the asset or purchase it for a set dollar amount called the residual or purchase option,” Edgington says. “The residual or purchase option is based on the percentage of the asset cost and expected value of the asset when the lease ends.”
Benefits to leasing
Edgington explains four benefits to using lease options in a farm management plan:
1. Preserve working capital. One of the greatest benefits of a lease for farmers and ranchers is the cost upfront, Edgington contends. Typically, a lease only requires the first lease payment at the beginning, meaning less money out of pocket. “Lease payments cover only a portion of equipment value to be depreciated over the course of the lease, often resulting in a lower payment than a loan,” he adds, “or payments free up cash flow for other purposes within the producer's business.”
He says leasing helps farmers keep money on hand for “unexpected expenses and the seasonality of agriculture.”
2. Secure fixed financing. “The lease payments are fixed for the full term of the lease,” Edgington says. “So, in today’s climate with lower cost of funds, it’s a good time to fix your rates.”
“The distinct advantage of a lease is payment flexibility,” he says. “These payments can be tailored to match producers cash flow with monthly, quarterly, semiannual or annual payment options. In addition to flexible payments, leases can also save or produce you money.”
He gives this example: A John Deere 9567 RT valued at $475,000 is given a five-year lease at 3.5% with a residual value of 45%. The lease annual payment is $69,100, while the loan is $105,405. “That is $36,000 less than a loan for the same term,” Edgington explains.
3. Succession planning. Edgington says a lease may be a fit for a farm looking to bring the next generation into the operation or to increase income to support another family.
An example: A farmer wanted to add two swine barns to the operation. The lease was for $2.2 million for 12 years with monthly payments and 20% residual value.
“The benefit to the customer was the 100% financing option, lower payment and the potential for the next-generation transfer at the end of the lease,” Edgington explains. “The lease increased farm income to support family members returning to the farm.”
4. Tax advantages. Leases offer benefits for tax purposes; however, Edgington is quick to point out that he is not an accountant, tax adviser or attorney. He says farmers should consult with these professions for legal tax and accounting advise for their operations. Still, he shares some thoughts on tax advantage of leases.
There are options to take depreciation and other deductions on the leased assets, Edgington says, just like a loan or cash purchase. However, “farmers can write off lease payments instead of depreciating assets,” he notes.
Since 2017, there has been a 100% bonus depreciation on new and used equipment, he says. However, it is set to adjust downward in 2022, and continue stepping down in the subsequent five years.
Producers need to understand whether their lease is classified as a true lease or conditional sale lease for tax purposes. A true lease is where the customer may be able to deduct their lease payment as an operating expense, rather than depreciating the asset. In a conditional sale lease, the customer takes depreciation on the asset rather than deducting the lease payments. This is like a loan.
For a true lease, farmers can have a steady write-off for the term of the lease, unlike the 100% bonus depreciation where all the benefit occurs in year one. With a typical loan, the equipment depreciates over the year of the asset.
Edgington sees leases as an opportunity for farmers to secure the latest in agriculture technology, free up cash and plan for the next generation.
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