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Tax Advantages
of Owning Alpacas.

Raising alpacas at your own ranch, in the hands-on fashion, can offer the farmer some very attractive tax advantages. If alpacas are actively raised for profit, all the expenses attributable to the endeavor can be written off against your income. Expenses would include not only feed, fertilizer, veterinarian care, etc., but depreciation of such tangible property as breeding stock, barns and fences. These expenses can also help shelter current cash flow from tax.

The passive investor using the agisted investment approach to alpaca ownership may not enjoy all of the tax benefits discussed here--but many of the advantages apply. For instance, the passive Alpaca investor can depreciate his breeding stock and expense the direct cost of maintaining the animals. The main difference between an active farmer and a passive investor involves the passive investor's ability to deduct his investment losses against his other income. The passive investor may only be able to deduct losses from his investment against gain from the sale of animals and fleece. The active farmer can take the losses against his other income.

Alpaca breeding allows for tax-deferred wealth building. A small farmer or investor can purchase several alpacas and then allow his herd to grow over time without paying income tax on its increased size and value. If the same amount of money was invested in a Certificate of Deposit, any interest earned would be currently taxable. In addition, the C.D. could not be depreciated, thereby offsetting the tax due on current income.
We recommend that you engage an accountant for advice in setting up your books and determining the proper use of the concepts discussed in this brochure. The very helpful IRS Publication 225, The Farmers Tax Guide, can be obtained from your local IRS office. The aim of this discussion of IRS rules is to make you more conversant in the issues of taxation as they relate to raising alpacas.

To qualify for the most favorable tax treatment as a farmer, you must establish that you are in business to make a profit. You cannot raise alpacas as a hobby farmer or passive investor and receive the same tax preferences as an active hands-on, for profit farmer. A farming operation is presumed to be for profit if it has reported a profit in three of the last five tax years, including the current year.

If you fail the three years of profit test, you may still qualify as a "for profit" enterprise if your intention is to be profitable. Some of the factors considered when assessing your intent are:

  • You operate your farm in a business-like manner.
  • The time and effort you spend on farming indicates you intend to make it profitable.
  • You depend on income from farming for your livelihood.
  • Your losses are due to circumstances beyond your control or are normal in the start-up phase of farming.
  • You change your methods of operation in an effort to improve profitability.
  • You make a profit from farming in some years and how much profit you make.
  • You or your advisors have the knowledge needed to carry on the farming activity as a successful business.
  • You made a profit in similar activities in the past.
  • You are not carrying on the farming activity for personal pleasure or recreation.
  • You don't have to qualify on each of these factors; the cumulative picture drawn by your answers will provide the determination. Once you've established that you are farming alpacas with the intent to make a profit, you can deduct all qualifying expenses from your gross income.

If you are a passive investor, you are still allowed the tax benefits discussed below. The issue is whether you will be able to take the losses on a current basis. All the losses can be taken against profits or upon final disposition of the herd. The discussion from here forward presumes you are a cash basis taxpayer and you keep good records. Accrual basis taxpayers would also be allow the same treatment, but their timing might be different.

First, the following items must be included in both a passive investor's and a full time farmer's gross income calculations:

  • Income from the sale of livestock
  • Income from the sale of crops, i.e. fiber
  • Rents
  • Agriculture program payments
  • Income from cooperatives
  • Cancellation of debts
  • Income from other sources such as services
  • Breeding fees

The following expenses may be deducted from this income. Please note if you are agisting your animals, not all of these deductions may apply on a current basis.

  • Vehicle mileage at the current per mile rate for all farm business miles
  • Fees for the preparation of your income tax return farm schedule
  • Livestock feed
  • Labor hired to run and maintain your farm (remember, you must not deduct the expenses of maintaining your personal residence)
  • Farm repairs and maintenance
  • Interest
  • Breeding fees
  • Fertilizer
  • Taxes and insurance
  • Rent and lease costs
  • Depreciation on animals used for breeding
  • Real property improvements such as barns and equipment
  • Farm or investment-related travel expenses
  • Educational expenses, which improve your farming or investment expertise
  • Advertising
  • Attorney fees
  • Farm fuel and oil
  • Farm publications
  • AOBA dues
  • Miscellaneous chemicals, i.e. weed killer
  • Vet care
  • Small tools having a useful life of less than one year
  • Agistment fees

Please note: For hands-on farmers, personal and business expenses must be allocated between farm use and personal use. For instance, with such expenses as telephone, utilities, property taxes, accounting, etc., only the farm portion can be expensed.

Once active or hands-on alpaca farmers have determined their net income or loss, it is included on their tax return as an addition to or a deduction from their ordinary income. Losses can be carried back for three years and forward for 15 years. To deduct any loss, you must be at risk for an amount equal to or exceeding the losses claimed. The "at risk" rules mean that the deductible loss from an activity is limited to the amount you have at risk in the activity. You are generally at risk for:

  • The amount of money you contribute to an activity
  • The amount you borrow for use in the activity
  • The passive investor's losses which are in excess of current income can be carried forward and taken against future income. In other words, the passive investor does not lose the deductibility of expenses, but the timing of the losses may be different.

All taxpayers must establish the cost basis of their assets for tax purposes. This basis is used to determine the gain or loss on sale of an asset and to figure depreciation. In determining basis, you must follow the uniform capitalization rules found in the IRS code. Animals raised for sale are generally exempt from the uniform capitalization rules, and there are other exceptions for certain farm property. You need to become familiar with these rules.

Once you've established the cost basis of your various assets, you take a charge for depreciation against your annual income. This process allows you to expense the historic cost of an asset to offset present income. The effect is to create non-taxable cash flow on a current basis. This benefit is especially attractive in an environment of higher taxes.

Alpacas in which you have a cost basis can be written off over five years if they are being held as breeding stock. There are several methods of writing them off, beginning with the straight line method which allows you to deduct one-fifth of their cost each year, except the first year, in which the code allows for only six months of write-off. There are also several accelerated schedules which allow for a larger percentage of the asset to be written off early. Alpaca babies produced by your females have no cost basis and cannot be written off, although they may qualify for capital gain treatment on sale.

Capital improvements to the active or hands-on alpaca breeder's ranch can also be written off against income. Barns, fences, pond construction, driveways, and parking lots can be expensed over their useful life. Equipment such as tractors, pickups, trailers and scales each have an appropriate schedule for write-off. The depreciation schedule for each asset class varies from three years to 40 years.

The original cost basis of an asset is reduced by the annual amount of depreciation taken against the asset. Other costs add to basis, such as certain improvements or fees on sale. The changes to basis result in the adjusted cost basis of the asset. Upon sale, excess depreciation previously expensed must be recaptured at ordinary rates. The recapture rules are a bit complex, as are most IRS rules, but the IRS Farmers Publication mentioned earlier explains them well.

When an asset is sold, say for instance a female alpaca which was purchased for breeding purposes and held for several years, the gain or loss must be determined for tax purposes. If this alpaca was purchased for $20,000, depreciated for two and a half years, or say 50 percent of its value, and then resold for $20,000, there would be a gain for tax purposes of $10,000. In other words, your adjusted cost basis is deducted from your sale price to determine gain or loss.

Once you've determined the amount of a gain, you must classify it as either ordinary income or capital gain. Ordinary income is currently taxed at a maximum rate of up to 31 percent and capital gains are taxed at rates of up to 28 percent. The sale of breeding stock qualifies for capital gains treatment (excepting that portion of the gain which is subject to depreciation recapture rules). Any alpacas held for resale, such as newborn cria which you do not intend to use in your breeding program, would be classified as inventory and produce ordinary income on sale.
If the present administration in Washington is successful in raising the tax on ordinary income, and capital gains remain taxable at a lower rate, the capital gains treatment of sale proceeds will become an attractive benefit of investing in alpaca breeding stock.

There are other tax-saving strategies that can be utilized in concert with investing in alpacas. For instance, you are entitled to claim a charitable deduction for the fair market value of a capital asset which you contribute to a qualifying charity or institution. You can also exchange like for like assets and avoid the tax of a sale. An example of this strategy would be an investor who wanted to diversify his bloodstock. If he sold his alpacas and simply bought more, he would be required to pay tax on his gains. If he exchanged his alpacas for others, there would be now tax due. Employing the exchange concept can be very beneficial; for it to work efficiently, a third-party buyer is usually introduced into the transaction. The model for this type of transaction would be a real estate exchange. A CPA would be familiar with the use of "like kind" exchanges and how it might benefit you.

Installment sale rules allow you to defer income to future years. If you sell an alpaca with credit terms, you can defer your gain until you receive payment (excepting that portion of the gain which is subject to depreciation recapture rules). If an animal dies of disease and is insured, you can use the involuntary conversion rules in the code. These rules allow tax-free replacement of your animal.

This discussion of tax issues omits a number of rules which could impact your taxes. Tax preference items, alternate minimum taxes, employment taxes and other concepts of importance were not discussed.. Whether we like it or not, this is a complicated world we live in; it often requires CPA's and on occasion an attorney. Whatever happened to the days when all you needed to farm was a mule, a plow and a strong back?

In summary, the major tax advantages of investing in alpacas include the employment of depreciation, capital gains treatment, and if you are an active hands-on owner, the benefit of offsetting your ordinary income from other sources with expenses from your farming business. Wealth building by deferring taxes on the increased value of your herd is also a big plus. It pays to keep your eye on the tax law changes instituted by Congress.
 
Alyssa Hallstead - Owner

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