xt7rn872wq0r https://exploreuk.uky.edu/dips/xt7rn872wq0r/data/mets.xml   Agricultural Experiment Station, Department of Agricultural Economics, University of Kentucky 1970 journals kaes_research_rprts_06 English University of Kentucky Contact the Special Collections Research Center for information regarding rights and use of this collection. Kentucky Agricultural Experiment Station Research Report 6 : June 1970 text Research Report 6 : June 1970 1970 2014 true xt7rn872wq0r section xt7rn872wq0r     ESTIMATING THE COMPARATIVE COST OF
1 CUSTOM HIRING, RENTING, LEASING, OR
? OWNING OF SELECTED FARM MACHINES
L By George B. Byers and Kenny L. Wade
 il RESEARCH REPORT 6 ; June I97O
  University of Kentucky :: Agricultural Experiment Station I
  Department of Agricultural Economics
 Y Lexington

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x * a
’

 TABLE OF CONTENTS
` Page
INTRODUCTION ....................................... 1
Problem and justification .................................. 1 p
Definitions ......................................... 2
Procedure and Objectives ................,................. 2
CAPITAL TRANSFER, CUSTOM MACHINERY CONSIDERATIONS, AGREEMENTS,
AND TAX CONSIDERATIONS ............................... 3
Capital Transfer ............................... . ....... 3
Custom Machinery Considerations ............................. S
Rental Agreements ..................................... 4
Lease Agreements ...................................... 5
Options .......................................... 5
Machines Leased ..................................... 6
Responsibilities ol` Lessee and Lessor ........................... 6
Example ol` Reallocation .................................. 7
Tax Considerations ..................................... 7
Tax Advantage ...................................... 7
Tax Consequences .................................... 8
Determining the Lease Validity .............................. 8
Tax Consequences to Lessee ................................ 11
AMOLINT OF USE FOR OWNERSHIP COST OF FARM MACHINES TO BREAK-EVEN ·
WITII THE COST FOR CUSTOM HIRED OR RENTED MACHINES ............ 11
Custom Hire, Rental Charge and Ownership Cost Comparison ............... 12
LEASING OF FARM MACHINERY IN COMPARISON TO FULL OWNERSHIP AS
INFLUENCED BY OTHER CAPITAL INCOME OPPORTUNITIES ............ 14
Net Fixed Cost Comparison ................................ 16
p SUMMARY .......................................... 17
LIST OF REFERENCES ....................... . ........... 18 ,
APPENDIX .......................................... 19
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1
C   LIST OF TABLES
i , Table Page
  I 1. Comparison of Depreciation and Lease Write-Off of Machinery ............ 9
  1 2. Customs, Rental, and Ownership Daily Costs for Two—Plow Tractor and 'l`wo-Bottom
  » Plow or Disk .`.................................. 13
I
  3. Net Fixed Cost for a Machine with List Price of $6,000 and Leased 1`or $2,000 per
  l it Year for Three Years with Option to Purchase or Purchased For $5,750 ..... 15
  y Appendix
Q l Table _
i ' 1. Ownership Costs for Selected Farm Machines ..................... 19
· E 1 2. Custom, Rental, and Ownership Daily Costs for Four-Plow Tractor and Four-Bottom
Q 1 1 Plow or Disk .,......... . ....................... 21)
1 , 3. Custom, Rental, and Ownership Daily Costs for Power—Take-Off Forage Harvester . . . 21
  r
I ‘ 4. Custom, Rental, and Ownership Daily Costs for Seyen—Foot Power—Take—Oi`i` Combine . 22
; l 5. Custom, Rental, and Ownership Daily Costs for Self—Propelled Combine ........ 23
1 1 6. Custom, Rental, and Ownership Daily Costs for Mower ................ 2-1
  i 1 7. Custom, Rental, and Ownership Daily Costs for Hay Rake ............... 25
1 i 2 8. Custom, Rental, and Ownership Daily Costs for Self—Propelled Windrower ....... 26
  1 9. Custom, Rental, and Ownership Daily Costs for Hay Conditioner ........... 27
  1 10. Custom, Rental, and Ownership Daily Costs for Power-Take·Ofi` Baler ......... 28
  L
1 1 E 11. Custom, Rental, and Ownership Daily Costs for Two-Row Mounted Corn Picker . . . 29 _
1 §
    12. Custom, Rental, a.nd Ownership Daily Costs for Sell`—Propelled Two-Row Cotton
T I 1 Harvester ...................................... 30
5 1 i .
L ,1 \ 13. Fixed Costs for Machinery Leased for $2,000 per Year for Three Years with Option to
y i Purchase or Purchased for $5,750 ......................... 31 A
1   1
  E 14. Income Opportunities from Released Capital for a Machine Leased for $2,000 per Year
  i with Option to Purchase or a Machine Purchased for $$5,750 ........... 32
Q 1V
 2 ` =
1 .

 t LIST OF FIGURES
9 Figure Page
1. Plowing or Disking Cost per Day—Two-Plow Tractor, Two-Bottom Plow or Disk . . . 13
3 2. Net Fixed Cost for a Machine with a List Price of $6,000-Net Fixed Cost for a Leased 1
Machine and a Purchased Machine with Various Rates of Earning on Capital . . . 15
5
Appendix
Figure
1. Plowing or Disking Cost per Day»Four—Plow Tractor, Four—Bottom Plow or Disk . . . 20
9 2. Forage Harvesting Cost per Day—Harvester, Blower, Two Tractors and Two Wagons . . 21
,0 3 Combining Cost per Day—Combine and Tractor .................... 22
H 4. Combining Cost per Day—Self—Propclled Combine ................... 23
)2 5. Mowing Cost per Day—Seven—Foot Mower .........,............. 24
93 6. Raking Cost per Day—Sevcn-Foot Rake ........................ 25
24 7. \\`indrowing Cost per Day—Ten—Foot Self·Propelled Windrower ............ 26
2_ 8. Hay Conditioning Cost per Day-Hay Conditioner ................... 27
D
26 9. Baling Cost per Day—Power Take-Off Baler ...................... 28
l0. Corn Picking Cost per Day—Two·Row Mounted Corn Picker and Tractor ....... 29
27
l 1. Cotton Picking Costs per Day—Self—Propelled, Two-Row Cotton Harvester ...... 30
28
29
30 i
31
32
\T

 ESTIMATING THE COMPARATIVE COST OF CUSTOM HIRING, RENTING,
LEASING, OR OWNING OF SELECTED FARM MACHINES
by
George B. Byers and Kenny L. Wade*
INTRODUCTION
Problem and_]ustification requirement, assuming that the rented or
leased equipment requires as much time to
Capital needs for Kentucky’s agriculture operate as does owned equipment. Rented or
increase as farm size increases and larger leased equipment may not necessarily replace
mechanized units supplement or substitute other farm machinery. When the rented or
for labor. With an increase in capital leased machinery is in addition to other
investment for machinery, a fixed input, the machinery, the labor requirement may reduce
shorter run income-stimulating uses of capital because of more efficient use of labor through
for fertilizer, improved livestock, etc., may be machinery. Therefore, the labor changes
neglected more than is economically caused by renting and leasing will be
advisable. Custom use, renting, and/or leasing determined by the changes in organization
of farm machinery lower the long-run capital and operation as influenced by the machinery
investment in machinery and expand the net program on the farm.
income of farmers with limited capital by In custom operation, labor is furnished
releasing capital for other profitable to operate the machines. Thus, with the use
operational uses. of custom-operated machines, the "on farm"
The extent of possible increased income labor force is reduced if the farmer has no
is controlled by the amount of capital averted alternative use for his labor displaced by the
by renting or leasing and the 1`atC of return of operator of a machine.
the additional dollars invested. By saving a Renting and leasing of farm machinery
relatively large amount of capital, acomplete are not widespread in Kentucky. A few
reallocation of resources and reorganization dealers have offered the service. Dealers in the -
of farm enterprises may be warranted. Lexington area were the first to offer the ‘
The labor requirement of the farm may service. The practice, therefore, is more
change both in quantity and skill according to developed in this area than in other parts of
the availability of labor and the current the state. Most of the leasing in Kentucky is
operation of the farm. lf the capital is shifted done in Bowling Green, Hopkinsville, 6
from machinery to other productive Paducah, Henderson, Louisville, and
enterprises, the productive enterprises Lexington areas.
increase, causing an increase in the labor Leasing requires additional managerial
#1*% _ and accounting ability on the part of the ‘
Professor of Agricultural Economics and Instructor of dealer This fact Su Ssts a reason for leasing
Agriculture at Morehead State University, respectively. This ‘   c
report is based pn and an expansion of an M.A. thesis of the bgirqg rngre concentrated ir] the larger
]F§`.1§Itiiilifzff°tE`S$$..’§?p§€§2.Ei{..’Z§$Z"£)“.§Z$,.€§Zi"2.$ dsaimliips- The 1¤¤Si¤s ¤¤¤¤s¢m€¤tS imc
Agricultural Economics, 1966. progressed to the point of being acceptable
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I legal agreements, excluding possible federal the length of time indicated in the agreement.
I I I   f income tax laws (the legality of purchase The fee is determined by the length of time
—   I I options is questionable in some of the used, normally one to five years. The lease
I   agreements). National and state farm agreement often carries the right of renewal
I machinery-dealers’ associations and the or purchase.
    machinery manufacturing companies Custom hiring is the paying of a fee for
I   . contribute in providing legal guidelines for the services provided by a machine and
I   I renting and leasing. operator. The fee is usually determined by the
I I ‘ The dealer’s charge for rented or leased number of units of products handled, i.e.,
I   I machinery substitutes for the annual fixed tons of hay, etc. Variable costs in operating
    ` I cost of ownership. The rental charge versus the machine, such as gasoline or baler twine,
I Q · annual fixed cost is the main cost comparison are also furnished by the custom operator.
I I . in operating owned and nonowned machines
I   I because in both cases the farm operator bears
I   I the variable costs, Procedure turd Objectives
t The Internal Revenue Service allows the
I fees of leasing, renting, and custom hiring to Farm machinery dealers in central and
I T . be completely deducted as annual operating western Kentucky were inteiwtiewed by
I   I expenses. A possible tax advantage exists in personal survey to determine policies and
I I leasing by deducting the fixed cost of the practices in use for rented and leased farm
I I machine more quickly than with direct machinery. Thirty—four dealers reported
  I ownership. leasing and/or renting eight brands of farm
I machinery. Ten dealers used leasing
I   arrangements and 33 dealers rented machines.
I Definitions Thirty-two farmers who had either
I   rented or leased farm equipment were
I I I Renting and leasing agreements in interviewed to obtain their evaluation of
I Kentucky form two categories based on the reduction in capital investment and change in
I length of run and options. The meaning and management practices that occur by
I I I I use of these terms are not synonymous non-ownership of farm machinery.
I throughout the literature or in the machinery The study had four major objectives:
I i I jargon.
I I Machinery renting refers to the paying of l. To determine whether renting or leasing
I a specified fee for the temporary possession of farm machinery reduces the capital
, of a machine and the rights to income requirements for farm machinery and
  {   accruing from the use during the specified allows a reallocation of resources,
I   time. The fee is a cash payment determined thereby resulting in higher net income to
  I % by the length of time used—normally less than a farm? This is presented theoretically by I
  I I I one year—or by the amount of service a budget that illustrates the economic
i I Q obtained or by the number of acres on which criteria involved in making rational
I I _ the machine is used. Rental agreements do decisions,
g   I not CBHY an OPUOU to purchase and HY€ 2. To determine the arguments for and
’* `I · automatically cancelled when the machine is against renting and leasing arrangements,
I I returned to the rentor. A common example is the empirical problems of participating
    the renting of a hay conditioner for one day farmers and dealers, the timeliness of
  I OY &W€€k· operation effects and the influence upon
I · Leasing is the paying of a specified fee earnings and labor requirements by
I for the temporary possession of a machine for induced changes in the organization of
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 l 3
farm resources and management practices use.
L' 3. To determine for leasing versus ownership 4. To determine the short-run, break-even
C of farm machinery the theoretical and point for selected custom hired and
lc actual effects upon machinery costs rented machines versus owned farm
ll caused by taxation and shifts in capital machines.
)l`
d CAPITAL TRANSFER, CUSTOM MACHINERY CONSIDERATIONS,
lc AGREEMENTS, AND TAX CONSIDERATIONS `
lg Capital Transfer provides the farmer with a year-round use of
°’ the machine; therefore, the timeliness
l·`our ways of obtaining the use of farm problem is dependent upon the managerial
maehinery——custom hiring, renting, leasing, ability of the farmer to use the machine at the
and owning—are most often used in proper time, the same as for an owned
Kentucky. Each way varies in capital outlay, machine.
labor requirements, and timeliness. With ownership the farmer must supply
ld Capital expenditure to purchase and capital to purchase and labor to operate the
ll labor to operate the machinery are avoided by machine. The timeliness problem, as in
ld custom hiring. Labor is furnished by the leasing, is reduced since the farmer has
m custom contractor to operate the specific constant access to the use of the machine.
Jd machine and to do the associated operations. The following is a condensed tabulation
m The influence of capital and labor savings of the ways to obtain the use of farm
ug upon the earning capacity of the farm is machines and their associated influence upon
JS` dependent upon the opportunity for their use capital outlay, labor, and timeliness:
Ul elsewhere in the farming enterprises than on
ini machinery operations. Timeliness of Farm operator avoids Farmer
(dl operation is a factor in custom hiring because Capital Control of
m the custom operator may not be able to outlay Labor timeliness
bl. perform the service when the farmer would
have maximum returns. The scale of custom Custom hire Yes Yes No
:5: operation varies from an operator with a Rent Yes No No
single machine to a fleet of machines such as Lease Yes No Yes
ng mowers, conditioners, rakes, balers, wagons, Own No No Yes
wl and elevators.
nd By renting machines the direct outlay of
CS’ capital for purchase is avoided but the farmer Custom Machinery Considerations _
IU . must provide labor to operate the machine.
lil Timeliness is affected by the ability to obtain Custom rates ¤oFm¤ll)` No hasod oh tho
mc the machine from the dealer at the opportune amount of accompllshmohh Although thc _
[wl time. Whether the timeliness problem of base is not COIlSiSt€I1t throughout Kentucky,
renting is greater than, equal to, or less than OVC? thho tho mms have Yohdod to become
md custom hiring depends upon many factors mow oqhal hom élloo to moo- Tho following
lm unique to each farmer. glo tYPlCal lates   i <
mg Capital outlay is lessened in the short
Ul run by leasing machinery but, as with renting, I. Corn pickings 3 8.00 per acre
Km the lessee is responsible for supplying the 2. Corn combining 9.60 per acre
bt labor to operate the machine. Leasing 3. Combining small grain 7.30 per acre
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i 4
i   4. Silage chopping and renting farm macl1111ery lll 1965, lour had a
S ` t blowing into silo: printed rental contract. O11e other dealer
i l V 2 men, 2 wagons; wrote tflti CO11{1`ztCt at the time of rental, and
l 2 tractors $17.90 per hour the remainder used oral agreements. Two
l _ ¤ 5. Silo filling 2.60 per ton dealers had printed rental rates for several
i . 6. Pick up baling—twine 0.15 per bale machines, but the majority established rates
l Q 7. Mowing hay, 2.60 per acre on the per-day or unit—of-aceomplishment
l   y raking hay, 1.60 per 8CIC basis at the time the rental agreement was
I . l » conditioning hay 2.60 per acre initiated,
l   1 8. Plowing—moldboard 4.40 per z1Cf€ The length of l`Llll of the rental
    i . disking—tandem 2.80 per &Cf€ agreement was dependent upo11 tl1e work the
* » 9. Corn planting with machine was to accomplish. ln tl1e survey 22
l _ fertilizer 2.90 per ?1C1`€ dealers reported renting farm Il1iiCl11I1CS in
l   . soybean planting 2.45 per acre 1965 for one particular job, with only 7
I cultivating—sweep dealers reporting most of their rentals for a
p cultivator 2.10 per acre week or more. The machines or units
l   10. Bulldozing 15.50 per hour evidently were more specialized for o11e job
l .1 1 and not for a seaso11 or multiple ofjobs.
l · T T h C P Y O vi d 1 U S O f t Y ai H 6 d Tractors were the machines offered most
l   Cu$tOm‘m3€hi¤€ OPEYMOY is an lmPOYmm by dealers for renting Some dealers offered
E consideration if extra labor is needed to {Or rem h uy Cohdhhyhcrs, hut- hdlcm
  i . operate the owned machine or if the machine eultivating equipment, rotary- niOwer5_
Q requires a high degree of skill to operate. For manure spreaders, combines, corn pickers,
l I . the more complicated machines the custom wagons, post-hold diggers, and grader blades.
l operator may be more skilled in operation A relatively high percentage of the
l than the hired laborer of the farmer and may farmers who rented tractors also rented other
l T provide a newer, more efficient machine than machines since many of these machines were
I the farm owner has or eanjustify. in a unit with a tractor. Only four of the
l Disadvantages exist in custom-hiring dealers rented tractors exclusive of any other
l l machines. The machine may not be available machines. Often the machinery dealers rented
{ at the opportune time. Weather or breakage machines to non~farmers, particularly rotary
I might detain the custom operator from mowers. These mowers were usually as a unit
. 4 performing the task when the farm operator with a tractor. Twenty-seven of the dealers
i would have received maximum benefits. The offered used machinery only for rental; three
  extra labor furnished by the custom operator had both new and used; and three, only new.]
. " 1 may not be needed, depending upon the Of the three who had 11ew machines for
1 l 1 r alternatives of the farm operator. In addition rental, only one offered tractors. The
{ 1 to the extra labor and the specialized machines available for renting would be
1 l machine, the farm operator may be hiring an dependent upon the stock of used machines
1 E { extra tractor and/or other machinery while on hand as a result of "trade-ins" on new
his own machines remain idle. machine sales at any given time.
2,   Typically, the renter is responsible for all
i`   costs except normal wear and tear and the
    Rental Agreements expense covered by the manufacturer`s
l | .-......--._.-._
  i Dealers who I‘€1'1t€Cl machines to farmcrg 1The term new" refers to machines not previously owned
Q ‘ in 1965 were distributed throughout Centra] b;’n;°m‘=°¤* °;*?” ¤**;·¤t <;¢jil¤·- b§lS<=ddm=¤¤¤¤i¤¤r; ~;¤¤.
E \ and westem Kentucky. Of the 33 dealers gome Oheinriiieaifei a A imo {dmc (mam C or
. l
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 5
, warranty. The renter with the one available at the time needed. Thedealer
l- above-mentioned rental agreement is exposed sometimes retains the right to sell the
1 to a risk of repair cost above those of normal machine before the farm operator rents or
, wear and tear and warranty because the while it is being operated at the renter’s farm.
1 chance exists of a major breakage caused by
S misuse during the rental agreement. The title
I to the machine definitely remains with the Lease Agreements
S dealer. The renter cannot subrent the machine .
but can do custom operations. Most leasing agreements were 3- or
rl The dealer is responsible for having the 5-year contracts, with many modifications
U machines in a good working condition when practiced to the basic form. Of the 34 dealers
g they left his place of business. However, the surveyed in 1965, nine already had a leasing
_, renter normally accepts the machine on good program, and one wasjust formulating a plan.
7 faith while the dealer accepts the machine Seven dealers offered the machinery for lease
Ll back in good faith. When the renter accepts a on a 3-year lease; 2, on a 5—year lease; and 1,
S machine on good faith, he is exposed to repair on a 6-month lease. To insure a reasonable
b and breakage risk that may have been caused return, the dealers were compelled to initiate
by prior users. an agreement that would insure enough length
,; Most rental charges, according to the of run to merit the purchase of machinery for
(1 survey, were made on a per-day, per—week, or lease. Since the lease charge was expressed as
s, per—month basis although some were on a some percentage of retail FOB price, the
s, per-unit-of-accomplishment basis. With both annual lease charge decreased as the length of
S, of the methods just indicated, the time of the lease increased.
S. payment was the termination of agreement. All leases were preprinted agreements
»C Only six of the dealers required the rental that became legal signed documents. Contrary
if payment in advance at the beginning of the to renting, no oral agreements were used in
`G contract. Significantly, the per-day charge was leasing. Only four of the dealers had a
l0 usually made for the entire time the machine preconsidered lease charge. The remaining six
if was away from the place of business, bargained for the amount of the lease
·d regardless of weather. The possibility, then, payment with the potential lessee.
‘y existed for a charge with no use some days.
it As does custom hiring, renting avoids Options
rs capital outlay for machinery and fixed cost of Lease arrangements included two types
;e owning machinery. No operator is furnished of options to obtain the use of machines. The
.1 when the machine is rented. Some problems lessee could extend the lease beyond the
ar of insufficiency of skilled labor with the more original time or purchase the machine by `
ie complex machines may occur even though paying the difference in the total lease ‘
Je none were noted in the study   The farmer payment and the retail price. The former was
es has full control of the machine to operate at offered by one dealer in Kentucky. This plan
W the speed and time he desires. A disadvantage was to extend the lease for the nominal ·
is that machines are not normally rented for amount of 2 percent of the retail price per
All less than one day. If a farm operator had only year with a maximum extension of 2 years.
lw %- or V2—day`s work to do, he would still have The latter option was more acceptable to the
F`S to pay for a full day. In this respect, it is a lessee. f
disadvantage compared with custom hiring. The purchase option can normally be
Wd Again, timeliness may be a disadvantage in utilized only at a specific time in the lease.
  renting. The farm operator’s ability to obtain The usual purchase option time with seven of
a machine depends upon the dealer having the dealers was at the termination of the

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l
i , _ lease. Two dealers allowed a purchase option equipment, planting equipment, and
j f _ at any time during the lease. When the option Cultivating equipment. Normally, this
` l to purchase was utilized, all or part of the equipment was leased on a unit basis with a
j previous lease payments applied to the tractor. Hay conditioners, hay balers, forage
  1 T. purchase price. For the 10 dealers leasing harvesters, and PTO combines were also
  g farm machines, an average of 91 percent of offered for lease. The dealers had a tendency
] g the previous lease payments was accepted as to offer only tractors and tillage equipment or
l   . _ payment on the purchase price of the leased tractors and crop harvesting equipment. l·`ive
1 g - _ machine. dealers had tractor-tillage equipment. The
y   A major problem for the dealer in leasing remaining three had some combination, and
    , g machinery was the taking of ownership of the two of these three dealers had only the hay
` . — 1 machine at the initiating of a lease. The conditioner as the erop·harvesting equipment
i y machinery dealer either financed the machine S eve n dealers leased only new
i   . himself, which required added capital machinery; two dealers had new and used
l _ investment, or arranged for other financing. machines; and one dealer leased used
Only three of the dealers used their own machines only. The dealer leasing used
I   financing, with two of these being in machines only had no new machinery and
.   i t conjunction with other sources. Local banks dealt (sold, traded and leased) only in used
  1 accepted the lease agreements on discounts equipment.
A   Q from six of the dealers, and one financed
  through the national machinery company. All Responsibilities of Lessee and Lessor
j I » major machinery companies offered their
5 , dealers aid in financing and in turn retained The lessee with a typical lease furnishes
j l ~ y the right of denial to lease. Prerequisites of at his own cost all fuels, lubricants, and
3 { _ $25,000 to $50,000 net worth for the operating supplies, including labor for the
j potential lessees have been established by the operation of the equipment. The lessee is
E machinery companies. A national leasing required to keep the machine well maintained
i agency had arrangements with five of the and repaired. Broken parts during the lease
y dealers to supply funds for leased machinery. are the lessee’s expense except repairs covered
i   j With this agreement the leasing agency took by the manufacturer’s warranty. The lessee
.   y title to the machine, and the local dealer was indemnified the lessor against all loss or
I   paid in full. The lessee made the lease damage to the machinery during the lease
y payment to the agency. The agency also had period. If the machinery is destroyed or
y net-worth standards that the lessee had to stolen, the lessee replaces the machine at his
1 meet. expense. The lessor has the right to inspect
L T i the machine at his will. The lessee is
  , Machines Leased responsible for delivery to and from the
i T y lessor’s establishment. Usually, the lessee is
1 l   Tractors represented the largest number not permitted to sublease the equipment but
j ’ of single machines leased in terms of the can use it for custom operations. Normal wear
» dealers’ offering. Nine of the ten dealers who and tear to the machine is not the
  j leased farm machinery had tractors on lease. responsibility of the lessee. This cost or
g g _ Tractor leasing in connection with other depreciation of the machine is a part of the
    g machines (multiuse) represents a high capital lease charge and was incurred by the lessor.
    requirement. This high capital requirement is Machine titles remained with the dealers
  j significant because leasing the machine will who were responsible for the cost of normal
  ` release more capital for other productive uses. wear and tear and property tax on the
i ‘ Three dealers offered land-preparation machine. The warranty, which normally was
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 7
id
lis in force for a purchased machine, could be Tax Considerations
L, transferred to the lessee for his use. All leases,
gc however, did not allow this transfer. The Tax Advantage
so lessor retained the right to assign the lease for
CV the lessee’s debts. From a tax standpoint, the tax
O} advantage of leasing a machine allows the
Vc farmer to charge off the cost of the V
hc Example of Reallocation equipment earlier for taxes than for a
nd y purchased machine. Using the option in a
M. Reallocation of Capital is possible when 3-year lease, which is typical in Kentucky, the
li a machine is rented instead of purchased. full list price of the machine was deducted in
.w Assuming a farmer has the capital to purchase the first 3 years, instead of deducting
Cd a machine but decides to rent instead of depreciation over the lifetime of the machine.
cd purchase the machine, the difference between From an economic standpoint, this was
gd the purchase price and the rental charge may significant because the larger, earlier
nd be allocated to other productive uses. For deduction saves on taxes now.
Lcd example, a farmer can lease, with option to A dollar saved currently has more value
purchase, a $6,000 tractor at an annual charge than a dollar saved in some future time
of $2,000 for 3 years. This tractor might have period. Also, if the machine were not retained
been purchased on a cash basis for $5,750. At by the farmer for its full useful life, he
the end of 3 years the purchase option is used obtains the equivalent of full depreciation by
ws at a nominal option price. At this point in the the lease agreement; whereas, using the
ind text the legality of the option for tax straight—line depreciation on a purchase, full
the purposes will be disregarded. The operator depreciation would not have been attained
is will have $3,750 for the next year to invest during the period of the lease. Realizing that
red elsewhere in his farm business. If the net the excess of the sale price over depreciation
asc return on his investments is 10 percent, then of the machine would be subject to income
md his net income will be increased by $375 (less tax, it still would be economically
see the income tax that must be paid). Therefore, advantageous to have received full
O,. in 1 year, the farm operator will have depreciation.
usc increased his net income by $375 plus The degree of the advantage of leasing
or $358.87 net reduction on income tax over ownership of a machine is dependent
his deductible due to leasing the machine or upon the depreciation method used and at
.ect $733.87 (Appendix Table 14, Col. 7, 8, and what point of time in the life of the machine
is 9). ln the second year, the operator has it is replaced. With an accelerated method of
[hc $2,483.87 ($3,750.00 + $733.87 — $2,000.00) depreciation and sale in the latter part of the ’
2 is as extra inputs. Again with the 10 percent machine’s useful life, the advantage would be
but return at the margin, $248.39 will be the relatively small. A definite advantage in the
wm. increase to net income plus net tax reduction lease could be obtained when the excessive ·
the of $383.01 or $631.40. The third year, wear and tear of the machine reduced the
or $51,115.27 is available to purchase inputs. In normal life to 2 or 3 years. For example, a
the the three years, the full list price of the custom—operated hay baler that is worn out in
machine is paid and the delay of payment has 3 years and if the tax laws pertaining to
ilers increased the l`armer’s absolute income by leasing allow the complete write-off as a
mal $51,340.99 through the earnings of the deductible expense, there could be an
the released capital. This absolute income is advantage in leasing the baler. With declining
was dependent upon the income tax bracket to balance and first-year additional depreciation,
which the farniey belongs, only 59 percent of the list price would be i

   V
* 8
I charged as depreciation in the first 3 years. surn—of— the·years digits method of
I I i Therefore, a l00 percent write-off of the depreciating a purchased machine, the total
. I machine would occur with lease compared to discounted gross taxable income over ten
I 59 percent with depreciation. The former is years is increased $31.37 (155,400.68 - _
I the tax advantage. $5,369.31) because of lower depreciation for
  ` The following is a year—by—year the sum-of·the-years digits method of I
I   . comparison of the deductions allowed under depreciation.  
I I the most common interpretation of the The size of the tax advantage described I
I I   federal income tax laws (Table 1). The in Table 2 will vary with the percent of return  
I -¤ following assumptions form the basis of the in Column l. lf instead of using 4 percent  
  I I calculations: return, 8 percent had been used, the tax  
I _ · Retail Cost Ofmachme $6,000 advantage would have increased considerably.  
I Salvage O V I
I Q . Life of machine IO years Tax Conscqucuccs I
I _ Length of lease 3 years _ _ _ _
I I Lease charge (A) 33 I/3 percent oflist Purchase options in the renting and
I ' price per year, org l€z1SlI1g Of machinery raise the complex legal
I i _ (B) 25 percent per year issues of whether the conditional trade
I with 25 percent agreement was a purchase or a lease. Inherent
’   I OP