The major tax advantages of alpaca ranching include the use of depreciation, capital gains treatment, and if you are a hands-on rancher, the ability to offset your ordinary income with expenses from your alpaca ranching business.
If you are not a hands-on (or active) rancher, many of the tax benefits discussed here also apply for the less active owner using the agisted ownership approach. For example, the passive alpaca owner can depreciate his breeding stock and expense the direct cost of maintaining the animal. The primary difference between the hands-on farmer and the passive owner involves the ability to deduct investment losses against 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 also deduct the losses against his other income.
You can also gain wealth by deferring taxes on the growing value of the herd. The latter is done through purchasing several alpacas and allowing your herd to grow naturally without having to pay income tax on the higher value and size. Comparing this to investing in a Certificate of Deposit (CD), the interest earned from a CD would be taxable (at least) yearly, and not deferred where it can further build wealth. In addition, the CD would not be depreciated.
To take advantage of the most favorable tax consequences you must make it known that you are in the alpaca business to make a profit. A ranching business shows this through reporting that they have made a profit in 3 of the last 5 tax years, including the current year. If a rancher were unable to do this the next step would be to prove your intention is to be profitable. The following are factors looked at for assessing intent:
- Your farm is operated in a business like manner.
- The time and effort spent working on the ranch shows you intend to make it profitable.
- Income from ranching is what you depend on for your livelihood.
- Your losses are due to the normal start up phase of a business or are beyond your control.
- There has been a change in the methods of your operation to improve profitability.
- You've made a profit in ranching and show how much of a profit you have made.
- You or your advisors have the knowledge needed to carry on the ranch and make it a successful business.
- You have made a profit in similar endeavors in the past.
- This ranching activity is not for personal pleasure or recreation.
Not all factors have to be completed; it's the total picture that will provide the determination. Once you have established an intention to be profitable, you can deduct certain expenses from your gross income.
If you are a passive investor you are still allowed the tax benefits discussed here. 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 following items must be included in both a hands-on rancher and an agisted owner's gross income calculation. This also presumes that you’re a cash basis taxpayer and keep good records. Accrual basis tax payers would also be allowed the same tax treatment, but their timing may be different.
- Sale of livestock income.
- Fiber sale income.
- Agriculture program payments.
- Cooperatives income.
- Debt cancellations.
- Income from other sources, such as services.
- Breeding fees.
The following are expenses that may be deducted. Keep in mind that agisted owners may not be able to apply these deductions on a current basis.
- Farm business vehicle mileage.
- Fees for the preparation of your income tax return farm schedule.
- Livestock feed.
- Labor hired to run and maintain your farm. Remember you can not deduct the expense of maintaining your residence.
- Farm maintenance and repairs.
- Breeding fees.
- Insurance and taxes.
- 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 are related to farming or investments.
- Attorney fees.
- Farm fuel and oil.
- Farm publications.
- Alpaca organization dues, such as MaPACA and AOBA.
- Miscellaneous chemicals.
- Veterinarian care.
- Tools having a useful life of less than one year.
- Agistment fees.
When a hands-on rancher has determined their net loss or income, it is included as a deduction or addition from their ordinary income. Losses can be carried 15 years forward and 3 years back. To deduct a loss, your risk must be equal or exceed the loss claimed. Generally you are at risk for:
- The amount of money you contribute to an activity.
- The amount you borrow for an activity.
owner's losses, which are higher than their current income, can go
forward and used against future income. They do not lose the ability to
deduct expenses; the difference is the timing of the losses.
Establishing the cost basis of assets is used to determine the loss or gain of a sale of an asset and to figure depreciation. Animals that are raised for sale are usually exempt from uniform capitalization rules, which are found in the IRS code. There are also other exceptions for certain types of farm property.
Alpacas that are included in your cost basis and are being held as breeding stock can be written off over 5 years. There are several methods that can be used when writing them off including the straight-line method and a few accelerated schedules that allow you to write off a larger percentage of the asset earlier. Crias have no cost basis and therefore, cannot be written off; however, they may qualify for capital gains when sold.
Capital improvements to the hands-on alpaca rancher can be written off against income. Such items as barns, fences, driveways, and parking lots can be expensed over their useful life. There is also a schedule for writing off equipment such as tractors, pickups, trailers, and scales. The depreciation schedule for assets varies form 3 to 40 years.
Other costs can add to the original cost basis of an asset, such as improvements or fees on a sale. These changes, including the subtracting of depreciation, makes up the adjusted cost basis of the asset. Upon a sale, the excess depreciation that had been expensed must be recaptured at ordinary income tax rates.
The sale of breeding alpacas qualifies for capital gains, except for the portion which is subject to depreciation recapture rules. Any crias that you do not plan on using in your breeding program would be considered inventory and would be used as ordinary income on sale.
The capital gains treatment of sale has become an even greater reason for breeding alpacas since the 1997 Tax Act reduction in the capital gains tax rate to a rate of 20% down from 28% for assets held over 12 months. This act also created a 10% capital gains tax rate for people in 15% tax bracket. For investments held at least 5 years the tax break provides a maximum rate of 18%.
There are several other tax saving benefits you can use while investing in alpacas. These include:
- Being able to deduct the fair market value of a capital asset that you contribute to a charity or institution.
- Being able to exchange like for like assets and avoiding the tax of a sale. An example would be a rancher wanting to diversify their bloodlines through exchanging their alpacas for others.
- Installment sales rules allow you to defer income to future years. If you sell an alpaca with credit terms you can postpone your gain until you receive payment.
- If an insured animal dies you are able to use the involuntary conversion rules in the code, which allows you tax free replacement of the animal.
This gives you a brief overview of some of the tax advantages of owning alpacas. We are not CPAs or tax attorneys; these and other important concepts (e.g. tax preference items, other minimum taxes, employment taxes, etc.) should be discussed with a knowledgeable CPA or tax attorney as part of your business plan.
Monday, July 25, 2011