Tax Consequences
Alpaca
ranching offers not only enjoyment, but it also can lead to
a fine income.
If you are raising alpacas for such an endeavor the
need for knowledge in the area of tax consequences is very
important.
If you 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.
Fiber sale income.
Rents.
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.
Interest.
Breeding
fees.
Fertilizer.
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.
Advertising.
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.
The
agisted 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.
An
example of this would be in the selling of a female alpaca
that had been purchased for breeding purposes.
If the animal had been purchased for $40,000 and had
been depreciated for 2 and a half years at 50% of its value,
and then resold for $40,000, there would be a gain for tax
purposes of $20,000.
The adjusted cost basis is subtracted from your sale
price to determine loss or gain.
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.
Back to: Allegheny Alpacas Home Page
To learn more, contact Jack & Jill Reinhart at:
Allegheny Alpacas
(724) 940-4045