By Sonja Flaagan
Have you decided how you will acquire the assets you need for the coming year?
With all the talk about Section 179 bonus depreciation being eliminated this year, there's been a lot of talk about leasing.
The model behind leasing is that the lessee (customer) only pays for the portion of the property's lifetime that they use. The primary advantage that comes to most people's minds when considering a lease is the fact that the leasing expense is fully tax deductible. The problem that occurs is the definition that some people use for a lease is not a lease according to the IRS or the accounting standards.
The Financial Accounting Standards Board Statement No. 13 created specific guidelines for accounting for leases. Leases are defined as either capital or operating leases. Capital leases are treated as the acquisition of assets and the incurrence of the corresponding financial obligation. An operating lease is treated as a current operating expense. The 2014 Financial Guidelines for Agriculture also use the terms capital or operating lease.
The IRS uses the term "conditional sales contract" when referring to a capital lease. The definition of a conditional sales contract is "exists when at least part of the payments are applied toward the purchase or entitle the taxpayer to acquire the property under advantageous terms". (Internal Revenue Service, 2007) An example of a conditional sales contract is when the buyout portion of the lease is $0, $1 or a similar lower number. Semi tractors or trailers often have a buyout of $3,000 to $5,000. These are still considered conditional sales contracts in the essence that you are able to purchase the vehicle for less than fair market value. If your lease is in fact a conditional sales contract it does not mean you cannot deduct the expenses but should be deducted as a depreciation expense over the useful life of the asset.
If you have a lease that is considered to be a conditional sales contract or capital lease you still have the advantage in that the asset or financing does not report to credit bureaus. This can be an advantage or disadvantage dependent on your current credit history.
You cannot deduct lease expenses in advance. If you lease a tractor for 5 years starting in 2015 and pay the first three years (2015, 2016, and 2017) in advance. Only 2015 is deductible in 2015, 2016 will be deductible in 2016 and 2017 in 2017. Unless a significant cost savings is achieved by paying in advance (or required to by contract), I would advise against the prepaying as it increases the complexity of accounting and bookkeeping in prepaying this item.
Flaagan is a North Dakota Farm Business Management Instructor at Northwood, N.D. contact her at Sonja.firstname.lastname@example.org