Why a Capital Lease Might be the Right Financing Option for Your Next Farm Equipment Purchase
Equipment leases offer several tax benefits that can be advantageous for businesses, including farms. These benefits can make leasing a compelling alternative to purchasing equipment outright. Here’s an overview of the tax advantages associated with equipment leases:
1. Deductible Lease Payments
One of the primary tax benefits of leasing equipment is that lease payments are typically fully deductible as a business expense.
Lease payments are considered an operational expense rather than a capital expenditure. As such, they can be deducted from taxable income in the year they are paid. This can reduce a business’s taxable income and, consequently, its tax liability.
According to the IRS, lease payments for equipment that is used for business purposes can generally be deducted in full each year as an ordinary business expense (IRS Publication 535, 2023).
2. Avoidance of Depreciation Recapture
When you own equipment, you are required to depreciate it over its useful life, which involves spreading the cost of the equipment over several years.
If you sell the equipment before the end of its depreciable life, you may face depreciation recapture, which can result in additional taxable income. Leasing avoids this issue because you don’t own the equipment, so there’s no depreciation recapture.
3. Potential for Off-Balance-Sheet Financing
Traditional equipment purchases typically result in the asset being recorded on the balance sheet as well as a corresponding liability for any financed amount.
Operating leases often do not appear on the lessee’s balance sheet, which can improve financial ratios and make the company appear less leveraged. This can be advantageous for businesses seeking to maintain strong financial ratios or attract additional financing.
4. Flexible Tax Planning
Leasing allows for more predictable and flexible tax planning.
Fixed lease payments make it easier to budget and plan for tax liabilities. Since lease payments are deductible, businesses can better manage their cash flow and financial planning throughout the year. Additionally, since payments are deductible, the timing of these payments can be aligned with the company’s financial performance and tax strategy.
Business owners often use leasing as a tool for financial and tax planning to ensure consistent cash flow and manage operational expenses (Journal of Accountancy, 2023).
5. Potential for Bonus Depreciation (For Certain Types of Leases)
Under recent tax laws, businesses can take advantage of bonus depreciation for certain types of equipment.
While operating leases do not allow the lessee to claim bonus depreciation directly, certain tax benefits related to leased equipment might be available if the lease qualifies as a capital lease or if the equipment is used in ways that allow the lessor to claim bonus depreciation, which might indirectly benefit the lessee through lower lease payments.
The Tax Cuts and Jobs Act (TCJA) of 2017 introduced significant changes to bonus depreciation rules, allowing for 100% immediate expensing of qualified property (IRS Section 168(k)).
Case Studies
Case Study: Greenfield Farms: A farm in Nebraska opted for an operating lease for a new irrigation system. The lease payments were fully deductible, which reduced their taxable income for the year. This approach also allowed them to avoid the complexities of depreciation recapture and improved their cash flow.
Case Study: Sun Valley Dairy: A dairy operation leased a new milking machine. The fixed lease payments allowed the business to maintain predictable expenses and improved their balance sheet ratios. The dairy was able to allocate more resources to expanding its herd and upgrading facilities without taking on significant debt.
In summary, equipment leases can offer several tax benefits, including full deductibility of lease payments, avoidance of depreciation recapture, potential for off-balance-sheet financing, and flexible tax planning. These advantages can make leasing a strategically beneficial choice for many businesses, including farms, helping to manage cash flow and optimize tax outcomes.
