Tax Consequences of Owning Alpacas

When we decided to get into the alpaca industry (Oct 2004), the benefits of two factors really stood out. First the gentle nature of the lifestyle appealed to us and second the favorable tax consequences sealed the deal. My initial research took me to several publications about the financial aspects of alpaca ownership. In this Advanced Alpaca Newsletter article I focus on a portion of the January 2007 publication from the Alpaca Owner and Breeders Association (AOBA) entitled Financial Aspects of Alpaca Ownership.

The answers to some of the most asked questions about alpaca ownership follow:

Tax Consequences of Owning Alpacas

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 discussed in this article. 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. If 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 (boarding) 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
* 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 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
* Interest
* Breeding fees
* Fertilizer
* 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
* Advertising
* 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.

 

Alpacas Are Green!!

Thoughts from Cindy Harris of Alpacas at Windy Hill as shared in Aug. 2009  green alpaca

When I think of green and alpacas, it usually conjures up either some idyllic image of rolling pastures and lazy days under the shade tree, OR the less lovely thought of partially digested hay and rumen dripping down the side of my face for some unintentional offense I committed while in the vet barn.

HOWEVER……… this time I was pondering the many ways in which alpacas are ideally suited to living an Earth Friendly life. Honestly– it’s nothing to spit at!

Did you know, for instance, that alpacas don’t have to be slaughtered to have value in this country? Who ever heard of livestock that didn’t have to be slaughtered? But actually, especially during this time of growing our national herd, the longer an alpaca is around, the better! That’s an alpaca fleece every year, as well as a cria from every female that lives another year. We’d be cutting our noses off to spite our faces if we slaughtered them right now—we just don’t have enough alpacas!

Alpacas only have a small impact on Mother Earth. They are quiet, and consume far less food and water, pound for pound, than other common livestock breeds. They are modified ruminants, having 3 stomachs, and are very efficient users of their food! Their pellet-like manure makes perfect ph-balanced natural fertilizer. Even at Windy Hill, with 400 alpacas, people are amazed that they can’t smell anything but hay.

Alpacas are also kind to the ground they walk on. Being camelids, their feet consist of two soft oval pads and toenails rather than a hard hoof, so even in wet conditions pastures are not trampled and bogged. Alpacas have no upper incisor teeth, although they do have efficient grinders in the back. Because they cut grass and hay with their bottom incisors against a hard palate, they make sure that pastures will last longer and grow better.

Clothes made from the prime alpaca fleece are mostly hypoallergenic because there’s no lanolin and the yarn is very smooth and soft. We can use ALL the grades of alpaca fleece. Even the coarser grades of fleece, usually from the legs, belly, and neck, are great for coats, socks, blankets, rugs, and upholstery. Scraps from the shearing room floor can be used to insulate outdoor pipes and make composting!

Alpacas are THE environmentally friendly livestock! Alpaca fleece surpasses all the synthetics, and sheep’s wool, too. It’s:

Sustainable—there is an ever-growing American herd on the horizon

Natural—not synthetic and absolutely biodegradable

Renewable—every year there is a fresh and growing supply of alpaca fleece

Durable—archeologists have found intact remains of Incan alpaca textiles

Organic—there is no need for the use of chemicals in raising alpacas or processing their fleece

Recyclable—many an alpaca baby blanket has been handed down through generations of children, its final destination the compost heap to help grow new pasture for the next generation of alpacas!

Alpacas are really the Livestock of the 21st Century!

If you have a thought about this blog… please share. Cindy and I will be happy to receive your comments.

Alpacas Are Quite Intelligent

As a species alpacas are more like cats than dogs and quite Intelligent.Anzanita 3 hours old

 

When people meet alpacas for the first time – they observe gentle, curious animals with big doe-like eyes looking back at them. An initial question usually turns to their type of personality. My usual answer is that alpacas are more like cats than dogs.

 

Let me explain ten reasons why:

 

  1. An alpaca will stand just outside your reach – until they get to know you.
  2. An alpaca is curious about anything in the immediate surrounding – and will sniff it cautiously.
  3. Alpacas learn their names and will come when you call them – or may not.
  4. Alpacas like treats and can get comfortable eating out of your hand – their tricks are a bit limited.
  5. Alpacas will run away if they get spooked – only to stop and turn around to see what it was that spooked them.
  6. Alpacas are very intelligent and choose to return to the poop pile – usually in the same place – much like a cat uses a litter box. (My dogs have never made a pile and choose to use the whole back yard.)
  7. Alpacas do not play fetch – like a dog. Instead they nibble with their split upper lip on the edges of “things”…
  8. An alpaca female is very protective of her cria the first few days – then lets it explore the surroundings openly – probably glad for the break.
  9. Alpacas take “cat naps” through out the day and night.
  10. Alpacas hum to communicate much like a cat “meows”. It can be very quiet and comforting or…very persistent and annoying.

What are your experiences of “alpaca personality?” I invite you to give me your comments.

Stability of Alpaca Market Values

julie with Coconut CrunchOne of my coaching clients asked a question that I’m sure is on the minds of many other alpaca enthusiasts … and that is all about the stability of alpaca market values.

So here is my personal opinion:

You see, because the most important source of revenue in the alpaca industry is the actual sale of livestock (particularly breeding females), and also because the 2nd most important revenue source (stud fees) are dependent upon the market price of alpaca livestock … the primary risk you take when you enter the alpaca industry is ‘market risk’. 

(Of course there ARE other risks besides market risk, … but the availability of very affordable alpaca livestock insurance eliminates many of these concerns.)

If you’re willing to embrace the alpaca lifestyle and work at it for five to ten years, most people should be able to grow their herds to a size which would be worth five hundred thousand dollars (and often more).  That’s because at today’s market prices, 35 – 40 registered alpacas are worth that much. 

So, as far as I can tell, the only truly significant risk we take when we decide to get into alpacas, is whether 35 to 40 alpacas will still be worth a half million dollars when we’re ready to get out. 

The good news is that the average alpaca costs between 10,000 – $20,000 now – the same price it cost during the introduction of the species in the U.S. 25 years ago. Although this market value is subject to fluctuation like any other market, the value has stayed nearly the same because demand has been keeping pace nicely with supply.  (The US herd is still pretty small.)

One of the reasons the Alpaca herd stays small is because the registry of imports is formally closed (here in the USA, we’re not allowed to bring in any more from outside the country) and because females can only have one “cria” (the term for an alpaca baby) each year (the gestation period is 11.5 months!) 

Breeders in the business for a decade or more will usually say they’ve seen the low-end prices for alpacas drop and the prices for the top animals increase. This is also an indication of the stability of the value in the market overall. (And a good reason to embrace the lifestyle fully if you’re going to do this, so that you really can learn how to develop high end animals.)

One of the first females we bought had a 4 month old female cria at side. I named her Coconut Crunch, CC for short. (See her 11 month picture above.) That was in August of 2004. Well, just this week, June 7, 2009, CC delivered her third baby girl! In addition to that, her first cria, Sedona, is pregnant and due in the fall. From that initial purchase of CC and her dam, our herd has grown by 6 (all females) with several more years of production ahead. We’re not ready to sell CC or her offspring yet … even though we’ve had offers from people to buy her.

These are some of my thoughts … what are yours?

Are Alpacas a Craze or Fad???

Feeding TimeWe had a visitor to our ranch the other day who had experienced a terrible financial loss in his family when they tried raising Emus & Ostriches in the 1980’s. So he was very curious about what made the alpaca investment different … since he had heard some of the same promises applied to that craze in the 1980s.

But I really don’t think they’re much alike at all, and here’s why:

First, with Emus, the profit center was supposed to be the meat market (which never really materialized in the U.S.)

With Alpacas, there is NO meat industry, and no one is relying upon it to produce revenue in their business model. 

That’s a good thing for two reasons.

First and foremost … if you have to slaughter an animal to derive value from it, you have an inherent limitation in your
model.

Second, you’re going to get kind of emotionally attached to these animals … (they’re very sweet) … so it would be heartbreaking to sell them for slaughter.

Emus also produced valuable oil, but not really enough to make a real profit.

But the biggest difference between the alpaca and emu industry is that one female emu could have DOZENS of offspring every year, which grew the USA herd size too quickly to allow for stable market values.  There was no way that demand could keep up with supply.

(The rapid reproductive rate of emus also made it difficult for farmers to keep up with expenses and needed equipment – and people were confused about how large an omelet you’d get from one Emu egg.)

Alpacas have only one baby a year, so herds grow slowly unless you buy more alpacas. (That’s also why it takes a few years to start earning significant income, and that this is an industry suitable for those willing to put in five to ten years.)

Another reason that alpacas appear to be a much hardier investment than emus is that the fleece usually earns enough money to feed the herd, and is expected to become more marketable over time.  So there is inherent stability for the alpaca farmer.

Last, because the value of an alpaca is directly related to the quality of it’s bloodline, alpaca farms often have a need to purchase animals from each other, or at minimum to buy breeding services. This creates the need/possibility to improve the genetics of the offspring and generate another revenue stream..

Long story short, although there is, of course, market risk in any investment, most of the experts I speak to, feel the alpaca market would remain stable for the foreseeable future, as it has for the past 20+ years.  (This is not a certainty though … only a probability.)

I worked with a professional researcher who tested this theory. He asked an MBA in finance who also happened to be a successful alpaca rancher what he personally would do if he inherited a hundred thousand dollars tomorrow.  He was anticipating that he would hear that he would be putting half in some type of safe and reliable instrument like treasury notes, some in stocks, and perhaps 25 – 30% into his alpaca business.

But this rancher pleasantly surprised the researcher by emphatically stating (without hesitation, I might add) that the 100% would go into alpacas. That validated exactly how I feel about my investment.

Please give me your thoughts on this subject by completing the comments section below.

Unique Alpaca Personalities

In a herd, certain alpacas will take the dominant lead while others may remain submissive. This seems to be the case with the females and the males. On the other hand, my experience is that when I get an alpaca alone… each one may exhibit entirely different personalities.

deadball

 

Many alpaca owners are drawn to the variety of behaviors that their alpacas display. A newbie may be surprised to learn that individual alpacas can be trained like horses, or dogs, or other pets if you take the time with them. 

 

For example:

  1. You can teach them to stand still while you put on a halter and lead. And teach them to lift their foot for toenail trimming.
  2. They will walk along side you on a lead once you teach them the basic skill. This is necessary if you wish to show them before a judge.
  3. With just a few lessons, you can teach them to jump into a van, horse trailer or modified auto.
  4. They can learn their name and come when you call them …especially when rewarded with a treat.
  5. At pellet feeding time… all I have to say is “TREATS” and point to the various catch pens. The ones that are fed in the assorted enclosures, stop, look at me, look at where I’m pointing and then run into the catch pens usually before I repeat “TREATS the third time.
  6. Some enjoy having their neck scratched – or side of their face. Some enjoy giving you kisses.
  7. If you get too friendly with one… he/she may become a bit of a pest and not respect your personal space or authority. (The ones that we bottle fed for a few weeks or more became so friendly that they would bite at my hat, untie my shoe laces, remove my gloves from my pocket and sometimes lunge at me if I didn’t get the food bowls down fast enough.) This is a behavior that needs to be addressed. It may be necessary to discipline the alpaca to prevent the unwanted behavior from persisting.

To get your respect back – try disciplining with a light tap on the nose with something soft like a Frisbee. If you do this at the first sign of unwanted behavior, usually it only takes 2 – 3 times before they get the picture and stop.

 

These are just a few of my experiences with their intelligence. What are your experiences of “unique alpaca personality?” I invite you to give me your comments.

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Let Uncle Sam Buy Your First Alpacas

Hello, my name is Coconut Crunch

Hello, my name is Coconut Crunch

If you are making (or are thinking about making) an alpaca purchase – consider this… 2009 is the best year to let Uncle Sam do it for you.

 

Let me explain…

 

The Stimulus Act temporarily extends the higher Section 179 expense amounts available in 2008 for an additional year. Under this provision, business owners can elect to immediately expense up to $250,000 of qualified equipment (alpacas qualify as equipment) purchased during the 2009 tax year, rather than depreciate it over time. This benefit will continue to phase-out on a dollar-for-dollar basis once qualified equipment purchases exceed $800,000.

 

The Stimulus Act also extends availability of the 50% bonus depreciation provision for capital expenditures incurred in 2009. This provision allows business owners to take 50% bonus depreciation in the year that the property is placed in service. In addition, the Stimulus Act extends the placed-in-service deadline for the $8,000 increase in first-year depreciation provision on qualified vehicles placed in service by December 31, 2009.

 

The current difficult economic situation has likely caused many businesses to incur a net operating loss (NOL) in 2008. Before the Stimulus Act, NOLs could generally be carried back only two years and, if there was a tax liability in those two years, taxes paid could be refunded to the taxpayer. For 2008 NOLs, the Stimulus Act extends the two-year carry-back to three, four, or five years increasing the likelihood, availability, and amount of the refund to enhance the business cash flow.

 

[The above information is for educational purposes only. This excerpt is from the April 2009 Tax & Business Alert bulletin from the CPA firm of Gish Seiden, LLP in Woodland Hills, CA – 818.854.6100]

 

Check with your local accountant to see in what ways the Stimulus Act might impact you or your plans to start your alpaca business this year.

 

Just thought you’d like to know!