Those considering entering the alpaca industry should engage an accountant for advice in setting up your books and determining the proper use of the concepts discusses in this brochure. A very helpful IRS publication, #225, entitled The Farmer's Tax Guide, can be obtained from your local IRS office. The goal of this discussion of IRS rules is to provide the guidelines for discussion with your accountants and financial advisors so that you can be more conversant in the issues of taxation as they relate to raising alpacas.
Raising alpacas at your own ranch, in the hands-on fashion, can offer the rancher some very attractive tax advantages, It alpacas are actively raised for profit, all the expenses attributable to the endeavor can be written off against your income. Expenses would include feed, fertilizer, veterinarian care, etc., but also the depreciation of such tangible property as breeding stock, barns, and fences. These expenses can also help shelter current cash flow from tax.
The less active owner using the agisted ownership approach may not enjoy all of the tax benefits discussed here but many of the advantages apply. For instance, the passive alpaca owner can depreciate breeding stock and expense the direct cost of maintaining the animals. The main difference between a hands-on or active rancher and a passive owner involves the passive owner's ability to deduct losses against other income. The passive investor may only be able to deduct losses from investment against gain from the sale of animals and fleece. The active rancher can take the losses against other income.
Alpaca breeding allows for tax-deferred wealth building. An owner can purchase several alpacas and then allow the herd to grow over time without paying income tax on its increased size and value until he or she decides to sell an animal or sell the entire herd.
To qualify for the most favorable tax treatment as a rancher, you must establish that you are in business to make a profit and you are actively involved in you business. You cannot raise alpacas as a hobby rancher or passive investor and receive the same tax benefits as an active, hands-on, for-profit rancher. A ranching 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 ranch in a businesslike manner.
The time and effort you spend on ranching indicates you intend to make it profitable.
You depend on income from ranching for your livelihood.
Your losses are due to circumstances beyond your control or are normal in the start-up phase of ranching.
You change your methods of operation in an attempt to improve profitability.
You make a profit from ranching in some years and how much profit you make.
You or your advisors have the knowledge needed to carry on the ranching activity as a successful business.
You made a profit in similar activities in the past.
You are not carrying on the ranching 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 ranching 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 allowed the same tax treatment, but their timing might be different.
First, the following items must be included in both a passive owner's and a full time rancher's gross income calculation:
- Income from the sale of livestock
- Income from sale of crops, i.e. fiber
- 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 for all ranch business (IRS publishes current rate)
- Fees for the preparation of your income tax return ranch schedule
- Livestock feed
- Labor hired to run and maintain your ranch
- Ranch repairs and maintenance
- Breeding fees
- Taxes and insurance
- Rent and lease costs
- Depreciation on animals used for breeding
- Depreciation of real property improvements such as barns and equipment
- Ranch or investment-related travel expenses
- Educational expenses, which improve your ranching or investment expertise
- Attorney fees
- Ranch fuel and oil
- Ranch publications
- AOBA (breed association) dues
- Miscellaneous chemicals, i.e., weed killer
- Veterinarian care
- Small tools
- Agistment fees
Please note: For hands-on ranchers, personal and business expenses must be allocated between ranch use and personal use; only the ranch use portion can be expensed for such expenses as a telephone, utilities, property taxes, accounting, etc.
Once active alpaca ranchers 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 owner's losses that are in excess of current income can be carried forward and taken against future income. In other words, the passive owner 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 ranch property. You need to become familiar with these rules.
Once you've established the cost basis of your various assets, you take a deduction 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 cost basis can be written off over five, seven, or ten 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 that 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, trailer, and scales each have an appropriate schedule for write-off. The depreciation schedule for each asset class varies from three years to 40 years.
There is also a direct write-off (expense) method known as Section 179 that allows a substantial deduction each tax year for newly acquired items that are normally long-term depreciable assets. While this is subject to several limitations, it is widely utilized by small ranches to accelerate expense, if that is appropriate for your tax situation. Owners currently in high tax brackets who are changing their lifestyle in the next several years to a lower income level often use it.
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 income rates. The recapture rules are a bit complex, as are most IRS rules, but the IRS Farmer's Publication mentioned earlier explains them well.
When an asset is sold, for instance a female alpaca that was purchased for breeding purposes and held for several years, the gain or loss must be determined for tax purposes. If an 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. 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 crias that you do not intend to use in your breeding program, would be classified as inventory and produce ordinary income on sale.
This discussion of tax issues omits a number of rules that could impact your taxes. Tax preference items, alternate minimum taxes, employment taxes, installment sales, additional depreciation, 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 the assistance of professional accounting and legal assistance.
In summary, the major tax advantages of alpaca ownership include the employment of depreciation, capital gains treatment, and if you are an active hands-on owner, the benefit of off-setting your ordinary income from other sources with the expenses from your ranching 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.