Decisions, decisions, decisions: Buy or lease? (Gary Sipiorski)
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By Gary Sipiorski, Vita Plus dairy development manager
Machinery values on a custom harvester’s balance sheet have a lot of zeroes.
Due to the field conditions and customer needs, the machinery sees a lot of abuse and many long hours of use, but it has to work when the crop is ready. Regular maintenance and attacks by the grease gun will keep the equipment operating. Replacement in a timely manner is important before major repairs are scheduled. Therefore, the equipment generally does not stay around for too many years.
As discussed at the Vita Plus Custom Harvester Meeting, advantages and disadvantages of buying or leasing should be investigated. The thought process should move along the following lines:
- Enough net income must be generated to not only pay present, but also future principal and interest or lease payments.
- With a healthy cash flow, new payments can be added with buying or leasing.
- If you buy a piece of machinery and finance it over a three- to five-year period, the interest cost is deductible on your taxes, but not the principal. You can depreciate the newly purchased piece, but only to what the tax code allows.
- A lender will generally take a blanket lien on the new piece and on all of the other pieces of machinery you own.
- If you decide to lease a piece of machinery, the entire amount of the lease is deductible from your gross income on your taxes. This is a nice tax advantage if the normal tax depreciation deduction is over a greater period of time. Once again, you must have income over expenses to make the lease payment work to your advantage.
- A leasing company cannot use the words “principal” or “interest rate” on a lease. Generally, when calculated, the lease will show a 2-percent effective interest rate compared to a normal loan and interest rate.
- The leased piece of equipment is owned by the leasing firm and cannot be put on your balance sheet. The leasing company is taking the depreciation.
- The leasing company will only take that single piece of equipment as a lien and no other machinery you already own.
- If you run your custom equipment for long hours and like to replace it before repairs are needed, a matching lease may be the correct decision.
- Read the fine print carefully on the lease agreement. If you want to pay the lease ahead, you will still owe the total lease amount that has been agreed to in the contact. Watch for terms such as general condition, hour limits, tire wear, etc.
- A discussion with your accountant is important in making the loan or lease decision. You must also monitor the ever-changing tax code on depreciation.
Business and economics