If you buy a piece of machinery, you own it, plain and simple. If you pay cash or buy it outright, 100% of its equity is yours once the deal is inked.
But, with the financial screws tightening down on grain and row crop producers from a continued sluggish marketplace, the money to buy that iron may not be available like it was a few years ago. That’s where leasing can help guide you through a tough spot in cycle of the ag economy. But, finding the right lease should be a process of weighing both short- and long-term financial outcomes.
If you’re on generally solid financial footing, you likely have some leasing options that can trim your payments now if you’re willing to sacrifice equity down the road. You’ll pay one way or another, but some options may be able to help you get through the ag downturn without taking too much of an immediate financial hit if you’re able to account for it once the grain marketplace springs back to life.
It’s all about how you structure your lease. Obviously, outright ownership is the highest-equity position into which you can put yourself, but it’s also the most costly way to buy, especially when borrowing. Leasing can be structured in myriad ways that dictate payment amounts, term lengths, residual and tax costs.
Leasing term options
Take overall payment amounts and lease term lengths. The lower your payment, the longer you’ll be making those lease payments. And, with lower payments, you’ll have a higher residual at the maturity of the lease, meaning you’ll have less equity and more left to pay if you decide to buy outright. In other words, you’ve paid for less of that machine through the life of the lease.
But, there’s a benefit to this strategy; if you are leasing, you may be able to amortize just a portion of a machine’s value, meaning you’re paying on less principle. Though that will automatically yield a higher residual at the lease’s maturity, you will have only made payments on a fraction of what you would have if you’d opted to purchase and make payments to a lender.
“For example, if you are leasing a $300,000 combine with a 50% residual, you’re only amortizing the first $150,000 of the sticker price over the course of the lease. That yields a lower lease payment than does a loan. When you start looking at shorter terms – two to three years, for example – you can have some high residuals, sometimes up to 70%,” says AgDirect territory manager Jill Patton. “A very small portion of the selling price makes up that payment. That has a huge advantage if you are looking to preserve cash.”
Tax implications vary
Then, there are the tax considerations. Leasing a piece of machinery based on an amortized value will yield a lower tax bill, leading to a smaller write-off; the lower the residual you leave once the final lease payment has been made, the more you’ve paid on that machine, giving you more value to write off at tax time.
Tax-wise, it comes down to understanding your unique tax situation and what’s going to be the most beneficial. Some producers want to lease with a lower residual so they can write off payments, though those payments will be considerably higher. The more cash-strapped producers want the lowest “bargain basement” price they can get, so they look for a lease with higher residual to free up cash flow. But, this structure minimizes the taxable amount paid on that machinery, keeping tax benefits low.
When looking to lease a new piece of machinery, it’s best not to look only at what can yield a lower payment and higher residual. Doing so can put you in an unenviable position down the road. The longer you stretch payments, for example, the less equity you’re creating on that machine, so when it comes time to replace it, costs will be higher.
“When a producer looks at a tractor on which they made $30,000 in payments in a year in the past and they’re ready for the ‘latest and greatest’ new model, the payments may jump $10,000 or $15,000 annually,” says Patton. “With a good residual position on a lease, you can stretch out the terms and keep the annual payment close to where it was before. Overall, it’s important to remember the highest residual isn’t always in your best interest.”
Ultimately, it’s important to consider both the short- and long-term implications of the structure of your next farm machinery lease.