If you are contemplating buying a grain bin, the initial cash outflow required may seem significant and the possibilities for structuring the deal endless.
Many farmers are also taking advantage of a new option from bin manufacturers and leasing companies to lease grain bins.
Although this option may offer benefits, the full financial and tax implications should be considered.
When considering whether to lease or buy a grain bin, many are interested in the more immediate benefits offered by a lease. With a lease you may be required to make a large payment upfront because the cost of the bin is incurred over the lease period. Many leases also provide the option to buy the asset at a reduced cost at the end of the lease term.
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Generally, the perception is that lease payments can be written off more quickly for tax purposes than the capital cost of a purchase.
Because lease payments are tax deductible, the entire lease payment can be written off as an expense when incurred.
If the bins were purchased instead, the price of the bin would be taken as an expense over a period of time through a tax calculation referred to as capital cost allowance.
When comparing the rate at which the purchase price is amortized to the cost of lease payments, it could appear that a lease is a better alternative.
The government considers acquired grain bins to be Class 6 assets that have a capital cost allowance rate of 10 percent. Therefore, for any bin purchased, only 10 percent of the amortized purchase price can be taken as a tax deduction each year.
While this appears to affect only purchased grain bins, this may not be the case. In certain circumstances, the government may consider leased grain bins to be capital leases instead of operating leases and treat the lease agreement as a purchase agreement.
Consider the tax consequence of a capital operating lease as compared to a standard lease.
If the government determines your lease to be a capital lease, the payments would not be considered as a tax deduction in the year the lease payments are paid. If you have been deducting the lease payments annually, the government could charge interest and penalties on the previous amounts deducted.
Also, tax consequences can result if you sell a bin you purchased at the end of a lease term. Rather than treating the disposition as a capital gain, which could result from the sale of a bin not purchased through a lease program, it may be required to include some of the lease payments as income in the year you dispose of the bin. Keep in mind that only 50 percent of a capital gain is subject to tax, while 100 percent of the lease payment addition would be subject to tax. This difference could result in a significant tax bill.
To determine whether your bin lease is defined as capital or operating, you must consider the lease terms. If it has any of the following terms, it could be a capital lease:
- the term is over a period that covers the entire useful life of the bin
- you have the ability to buy the bin at the end of the lease term
- the purchase price of the bin at the end of the lease term is lower than the fair market value of the bin at that date
The government puts emphasis on the ability to buy the bin at the end of the lease term when it is determining whether the transaction is a capital lease.
It is easy to see that the decision whether to buy or lease grain bins is complex. The benefits of a lease could be outweighed by the tax implications if the tax department determines that the lease is a capital lease.
It is important to get the advice of a professional adviser.
