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Equipment Leasing Could See Boost

November 14, 2012
By: Ed Clark, Top Producer Business and Issues Editor
 
 

Reduction of Section 179 in 2013 could boost leasing option

Leasing has a small, though respectable, share of the farm equipment finance pool even with several political and economic factors against it: six-digit equipment write-offs in the Internal Revenue Service code in year one and strong incomes giving farmers plenty of cash.

Change either of those variables and leasing suddenly looks far more attractive, experts say. Even so, there are conditions under which leasing makes smart business sense today, and some suggest an uptick in leasing is already occurring for several important reasons.

"Leasing improves cash flow and requires less money up front," says Kevin Smallwood, director of marketing and program management for AGCO Finance. As a result, it frees up capital for other farm investments.

"While annual payments are generally lower for leasing, for farmers in higher tax brackets, the expensing tax credit options often offset that. Thus leasing right now makes the most sense for producers who have a low marginal tax rate or need to preserve cash flow."


Leasing offers farmers other benefits too. Smallwood says sometimes a producer is a long-term user of a specific brand of equipment but would like to try something different with new features. Leasing is a low-risk way to do that. For producers who trade equipment every couple of years, leasing can offer advantages in the form of lower-cost payments compared to owning, he says.

What share of farm equipment market is leased? "Less than 10% of AGCO equipment is leased,
and that’s the industry norm," Smallwood says. The most popular items are high-horsepower tractors and application equipment. Financial Benefits. Leasing isn’t just about flexibility,  Smallwood says. It makes managing risk easier by making per-acre cost calibration simpler to determine.

"Leasing typically reduces cost per hour, per acre on per bushel," says Tim Biewer, marketing  director for CNH Capital. Leasing has increased recently as more producers see the advantages of using versus owning. Leasing typically offers the potential to have the latest in technology and perhaps higher horsepower or more features sooner compared with a purchase, Biewer explains. Leasing also fits in well for producers who are renting more land but would like to avoid getting locked into long-term equipment payments, he adds.

If all this is true, why don’t more farmers lease their equipment? "Pride of ownership, pure and
simple," says William Edwards, an Iowa State University agricultural economist. "That, along with tax code advantages to purchases and the fact that leasing does not make economic sense for producers who plan to own equipment for a long time."

If Congress doesn’t extend this year’s $139,000 Section 179 expensing option and the 50% bonus firstyear depreciation deduction, Biewer sees the potential for an increase in leasing beginning in 2013. Such tax breaks are popular, so it’s possible that Congress will extend them in the lame duck session.

While annual payments are generally lower for leasing, for farmers in higher tax brackets the expensing tax credit options often offset that. Thus leasing right now makes the most sense for producers with a low marginal tax rate or that need to preserve cash flow, says Troy Dumler, an  agricultural economist at Kansas State University. For example, in a study he conducted with other economists, he found that on a piece of equipment with annual payments of $60,000, leasing cut them by $20,000, but tax deductions often made up the difference. "That said, there are few rules of thumb," he says. "You have to run the numbers."

Calculate Your Machinery Costs

One production cost some producers struggle to track is an accurate read on machinery costs per acre—a crucial underpinning to knowing total production costs. Without it, you can’t accurately gauge profits, says Bret Oelke, University of Minnesota Extension regional educator, business management. "The risks of not knowing are low when crop prices are high, but that can change," he says.

Developing an accurate machinery cost number is not easy because it incorporates everything from depreciation to interest costs and from payments to fuel and oil costs—and that’s just the beginning.

To help producers through the machinery maze, Oelke has developed a series of spreadsheets to monitor a variety of farm costs and returns, machinery costs included. For instance, a sample farm has fixed machinery costs of $104.37, with fixed repair costs of $11.90. The kicker, however, is that you can’t look at machinery costs in a vacuum, as they have to be compared against changing land costs, Oelke says.

By renting an additional 500-acre farm for $325 per acre, total cash rent increases by $22.66 per acre to $232.55, and total land costs increase by $18.97 to $229.36. Circle back to machinery cost: At the same time land costs go up, machinery costs per acre decline by $17.28—from $104.37 to $87.09 because machinery covers more acres. As a result, by adding 500 acres, net income actually increases by $50,000.

What these numbers show, Oelke says, is the importance of matching machinery and labor with optimal acres farmed. For a copy of Oelke’s spreadsheets, which allow you to plug in your own farm numbers, e-mail him at oelke002@umn.edu.

Machinery Cost Calculator

Market Value of Owned General Farm Equipment and Trucks $1,950,000
(Do not include the value of leased equipment)

Debt Against General Farm Equipment and Trucks $700,000

Machinery Equity $1,250,000

Return on Equity Goal 10%
(This is a calculated return to equity in your machinery investment )

Annual Principal and Interest Payments on General Farm Equipment and Trucks $120,000

Annual Lease Payments on General Farm Equipment and Trucks $18,000

Total Annual Principal and Interest and Lease Payments $138,000

Equity Return $125,000

Total Annual Fixed Machinery Cost $263,000

Total Tillable Acres for Current Year 3,020

General Farm Equipment and Truck Investment Per Acre $645.70

Fixed Machinery Cost Per Acre $87.09
(Use this in your budget for general crop production fixed machinery cost per acre)

Last Year Schedule F Repairs and Maintenance $14,000

Two Years Ago Schedule F Repairs and Maintenance $52,000

Three Years Ago Schedule F Repairs and Maintenance $24,000

Average of Past Three Years’ Repairs and Maintenance $30,000

Repairs and Maintenance Per Acre $9.93
(Use this in your budget for machinery repairs)

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FEATURED IN: Top Producer - Mid-November 2012

 
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