Canadian farmers face the critical decision
of leasing versus buying equipment and
machinery.
Crowe MacKay's trusted Agriculture industry advisors break the
dilemma down, analyzing the lease vs buy debate, tax implications,
and cost comparisons to help farmers decide what best suits their
business.
Leasing Equipment and Machinery
Pros of Leasing
Lower Initial Investment
Leasing requires minimal upfront capital, which can be great for smaller operations or those just starting. This lower cost barrier allows farmers access to much-needed, high-quality equipment without significantly impacting their cash flow.
Maintenance and Repair
Leasing equipment, often the latest models, typically requires fewer repairs and maintenance. This results in a more predictable cash flow for expenses. Additionally, it lowers the risk of downtime during harvest periods due to equipment failure.
Tax Advantages
Leasing certain machinery and equipment, such as grain bins, can lead to quicker tax write-offs compared to purchasing them.
Reduced Risk of Obsolescence
Rapid technological advancement means that owned equipment can quickly become outdated. Leasing allows farmers to keep up with the latest technology without risking being stuck with obsolete equipment.
Buyout Option
Typically, farmers set up leases where there is a buyout option that is quite attractive, so they can still have the option of having equity. Some leases offer the flexibility to pay the buyout or return the equipment/machinery.
Cons of Leasing
Long-term Cost
Although leasing requires a lower initial investment, the cumulative cost of lease payments can exceed the cost of purchasing the equipment outright.
Restrictions on Use
Lease agreements can come with usage restrictions, affecting how and when the equipment can be operated. This restriction can be particularly challenging during peak seasons when usage is at its highest.
Penalties for Early Termination
Farmers may face penalties if they decide to end a lease early. This can be a disincentive to adapt to changing market conditions or technological advancements.
Buying Equipment and Machinery
Pros of Buying
Ownership and Asset Accumulation
The primary benefit of buying equipment/machinery is that it allows farmers to accumulate assets in the form of the equipment itself. This can build equity over time and provide potential resale value.
Tax Advantages
Purchasing equipment can lead to tax advantages through CCA (capital cost allowance) and Section 179 deductions. CCA allows farmers to account for the wear and tear on the equipment over its useful life, offering a way to recover some of the equipment cost through annual tax deductions. Meanwhile, Section 179 of the tax code permits farmers to add the full purchase price of qualifying equipment in the year it's put into service to the UCC (undepreciated capital cost) pool, up to a certain limit. This can lead to substantial tax savings, particularly in the year of purchase, improving cash flow and reducing the net cost of the equipment.
Example:
Consider a farmer who buys a tractor for $400,000. This would create an addition to the Class 10 automotive UCC pool of $400,000 in the year of purchase. The farmer would then get a tax CCA deduction of 30% of the $400,000 in the first year, which would work out to $120,000. This will save tax at a rate varying depending on the farm's structure (company, partnership, sole proprietor). Each year following the year of purchase, the farmer gets a tax deduction of the balance of the UCC, which in this case is $280,000 at the 30% rate, which would be $84,000 in year 2. This would continue over the following tax years with a smaller and smaller tax deduction.
Long-Term Cost Savings
Ownership over the equipment's useful life can be more cost-effective than continuous lease payments. Although the upfront cost is substantial, the absence of ongoing payments can lead to long-term savings. Additionally, if the machinery is financed, the cash flows can spread over many years.
No Usage Restrictions
Farmers who own their equipment are not subject to any usage restrictions. They can operate their machinery as much as necessary without concern for penalties or overage fees, which is excellent during peak times.
Cons of Buying
Initial Capital Requirement
The upfront cost of purchasing new equipment can be significant, depending on your farm's size and structure type. Farmers may struggle with funding the required down payment for farm machinery and equipment.
Maintenance Responsibility
With ownership comes the responsibility for all repairs and maintenance costs. This can be unpredictable and lead to high expenses, particularly with older equipment. This can result in unexpected downtime during peak seasons, meaning less production.
Recapture
When a farmer decides to sell a used piece of equipment they had previously purchased, the proceeds on sale of the equipment get netted against the UCC pool for that class of equipment. As current resale values for equipment are quite high, this could potentially result in a repayment of prior year CCA tax deductions with what is known as recapture, if the proceeds included in the UCC pool make the balance go negative. This situation would not occur if leasing equipment.
Reduced Flexibility
Once purchased, farmers are committed to their choice of equipment for long periods. Due to high costs, changing or upgrading equipment and machinery to evolving needs may be difficult.
Risk of Obsolescence
Owned equipment faces the same risk of obsolescence. Farmers may have to reinvest in new machinery to stay competitive or maintain efficiency.
The Pros and Cons of Operating and Capital Leases
A lease agreement will fall under one of two categories for accounting purposes: an operating lease or a capital lease. Each has pros and cons, but there is one distinct difference between them.
The main difference between operating and capital leases is whether you get a buy-out option at the end of the lease and whether you decide to pay the buy-out.
Capital leases are set up, so you might end up owning the asset after the lease is over, which gives the farmer the benefit of the asset's equity. On the other hand, operating leases are like renting, with no option to own the asset later.
Operating Leases
Pros
- Flexibility of upgrading assets more frequently
- Maintenance and repair responsibilities may fall on the lessor
- Lower risk of asset obsolescence
Cons
- No asset ownership
- Total leasing cost will be higher than the direct purchase cost
- No gains in potential asset value appreciation
- Constraints in tailoring/modifying the asset
Capital Leases
Pros
- Transition to asset ownership after the lease term is completed
- Assets can be customized and utilized without significant restrictions
- Potential to profit from the asset's value increases over time
Cons
- Increases long-term liabilities on financial statements
- Requires comprehensive financial reporting
- Lessees bear the cost of maintenance and repairs
- Faces the risk of the asset becoming obsolete before the lease ends
The main difference between operating and capital leases is whether you get a buy-out option at the end of the lease and whether you decide to pay the buy-out.
Capital leases are set up, so you might end up owning the asset after the lease is over, which gives the farmer the benefit of the asset's equity. On the other hand, operating leases are like renting, with no option to own the asset later.
Cost Comparison
Leasing Cost Considerations
Monthly Lease Payments: These are the main leasing costs. Compare these to the costs of buying outright.
Additional Fees: Lease agreements may include various fees such as late payment, setup, and early termination fees.
Interest and Money Factor: While not as straightforward as with a loan, the cost of money remains a factor in leasing. The money factor calculates interest in lease payments and can be compared to loan rates for an accurate cost assessment.
Buying Cost Considerations
Purchase Price: This figure should be considered in terms of the equipment's expected lifespan and potential resale value.
Financing Costs: Farmers without the required finances may need financing, with loan interest rates inflating total ownership costs.
Opportunity Costs: Funds used for equipment could be invested elsewhere, each with its own opportunity cost to consider in comparison.
Depreciation: Equipment devalues from use and wear over time, impacting finances and taxes.
Conclusion
Leasing or buying farm equipment requires careful consideration. Both options have pros and cons affecting finances and operations, and the best option can change based on the current situation. It is rarely one-size-fits-all. Canadian farmers must assess the long-term impact of their equipment decisions based on their needs and goals.
Ready to optimize your operations and financial health? Contact Crowe MacKay's trusted Agricultural industry advisors today for personalized advice on whether leasing or buying equipment is the right move for your farm.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.