CB-Lancaster Farming, Saturday, December 10,1988 F IS#] MANAGEMENT MACHINERY OWNERSHIP VS LEASING BY JOHN DEFASSIO Multi-County Farm Management Agent Penn State Cooperative Extension A common Question that is raised today is “Should I Lease or Purchase my next investment in machinery?” The answer doesn’t come as easy as the question. What is a Lease? The first thing we should estab lish is the fact that the term lease is use to mean anything from a two day rental to a financing arrange ment that passes ownership in an asset. The IRS views an operating lease and a finance lease as deduc tible on schedule F. A lease that is actually a conditional sales con tract must be separated into inter est and other charges, and princi pal payments. Each component of the lease purchase must be deducted or capitalized and depre ciated as provided by the IRS Code. Operating lease An operating lease is a short teim lease which does not transfer the ownership of the leased prop erty. This type of lease can be very beneficial and economical. An operating lease is useful if you need the use of equipment for a short period of time. For example you may rent a no-til planter to try a field of no-til soybeans. Finance lease. A finance leases applies to farm leases entered into from July 1, 1982 to December 31, 1987. The finance lease set a safe harbor amount that allowed a farmer a deduction, as rent, even if a purch ase occurred. The leased property trad to be new and could not axceed $150,000. Finance leases applied only to property eligible for investment credit. The purch ase option had to equal at least 10% of the original cost of the property. WOO CASH COSTS ; PAYMENTS S INCOME TAXES $20,000 $15,000 $lO,OOO $5,000 $0 1 2 3 ■ A PURCHASE S 3 B LEASE CASH ROW PURCHASE A VS LEASES YBW A PURCHASE 1 «1 1.668 >14.057 114.974 il 5.737 116.401 >3.637 >5,637 16.052 >6161 TOTAL AGAM New since January 1, 1988 Under current regulations a lease is considered a conditional sales contract if ownership changes or any equity toward ownership is gained. The mere right to buy the property after hav ing made all the required pay ments creates a sales contract. The option to buy will now have to equal the fair market value at the time the option is exercised if IRS is to consider lease treatment. Rent vs. lease example Assuming that the lease arrangement qualifies as a rent deduction: A farmer agrees to pay $40,000 for a new piece of farm equip ment. The total amount plus $2OOO for PCA stock will be financed at Farm Credit over a 5 year period. The interest rate is 11% variable. The cost per month is $913.18 as long as the rate docs not change, or a total 5 year pay out of $54,791 less $2,000 from the sale of the stock for a net pay out of $52,791. B farmer arrives at the same $40,000 agreement but elects to lease the equipment over a five year period. The lease at First Val ley Leasing will cost $932.00 per month. At the end of five years B will have paid out $55,920. How ever, in order to own the equip ment B will have to purchase it for it’s fair market value. Assuming a $4,000 value on the equipment the total pay out grows to $59,920. Penn State Cooperative extension in using trade names makes no endorsement of individual pro ducts or services. Leasing provides a tax advantage. B farmer gains a $2210 lax advantage assuming a 31% tax rate (15% federal, 13% self employment, 2% state and 1% local). In addition an advantage in cash flow is realized by leasing in the third through fifth years. The cash flow advantage belongs to A in the first, second and sixth 4 5 YEARS A - B BLEASE • 2518 -127 >14.164 >14.184 790 1553 >14.184 221 114.184 • 5590 >9.227 -630 >6.467 -4920 93081 .6 7 8 IF MVESTEO TAX FREE AT S% 2518 2898 790 2393 3043 3195 4719 3355 4955 9112 5202 10390 5402 11333 540 11333 5971 through eighth years, (see Cash over the eight year period. To lose dual needs to examine the fact Costs graph) this advantage due to the 11% var- and calculate the advantages fo Taking a closer look, * a ble interest rate the rate would casc Making the assumption that far- have l 0 exceed 16.5% for the life p enn state Cooperative exten mer A& B are equal in all *l*® loan. sion can now p rov ide analysi respects, except for the decision to Be careful in shopping for through the use of a compute lease vs purchase and their tax bill financing of capital acquisitions. p ro gia m called FINPACK. Exa without the new equipment would Many salesmen will tell you leas- mining alternatives under FIN be $6,467 at 31%, we can calcu- in 8 has aUx a dvantage, a cash may prove useful in mat late the next effect of the lease vs flow advantage and it will not tie many farm financial decisions purchase. If each farmer takes the U P othcr capital. This, as shown in More information about FIN excess cash flow and invests it in t* l6 example, is true to some PACK can be obtained from you 5% tax free bonds A (purchase) degree, but the bottom line favors equal opportunity county exten increases his advantage to $5,871 purchasing. Othcr factors must s j on o ff ice _ _ _ also be considered so each indivi- CASH FLOW PURCHASE A VS LEASE B YEAR A PURCHASE TOTAL AGAIN CASH COSTS ; PAYMENTS & INCOME TAXES $20,000 $15,000 $lO,OOO $5,000 $0 HOLD IT ...in a RED ROSE utility building. For little more than the cost of an ordinary garage, you can enjoy the organized, uncluttered life that goes with a Red Rose utility building. / ROSE BUILDING SYSTEMS BLEASE $14.184 111.666 $14.184 114.057 114.974 114.184 $14.184 115.737 $16.401 $14,184 $3.637 19.227 $6.467 15.637 $6.467 16.052 88161 93081 1 2 3 ■ A PURCHASE S BLEASE Name Address Town County (215) 267-4911 Mail To Box P-50, RD 2 • Stevens, PA 17578 A - B -2518 -127 790 1553 2217 -5590 -830 -41 5l -4920 4 5 YEARS Protect the things you value There’s plenty of room for all the things you value and want to protect cars, trucks, vans, motor- homes, boats, etc.—with lots of space left over for a workshop or hobby area, if you want one. It’s a won derful way of life. Why settle for anything less? Especially right now, at our low ‘off-season’ prices. CALL COLLECT OR MAIL COUPON FOR MORE INFORMATION State IF INVESTED TAX FREE AT 5% A B 2518 2898 3043 3195 3355 9112 10398 113331 11333 5871 6 7 8 790 2383 4719 4955 5202 5462 54621
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