Tax Benefits of Owning Alpacas

Raising alpacas at your own ranch, can offer you, 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 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 who agists (i.e. boards animals at another breeder’s farm) may not enjoy all of the tax benefits discussed here, but many of the advantages apply. For instance, the passive alpaca owner can depreciate his breeding stock and expense the direct cost of maintaining the animals. The main difference between a hands-on or active farmer and a passive owner involves the passive owner’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 owner 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 CD could not be depreciated, thereby offsetting thc 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. A very helpful IRS publication, #225, entitled 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 businesslike 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 attempt to improve profitability.
  • You make a profit from farming in some years, and and the amount of 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 allowed the same tax 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 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 farm business miles (IRS publishes current rate)
  • 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 expense 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 (breed association) dues
  • Miscellaneous chemicals, i.e., weed killer
  • Veterinarian care
  • 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; only the farm use portion can be expensed for such expenses as telephone, utilities, property taxes, accounting, etc.

Once active 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

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 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 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, 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.

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. This allows for the hyper-depreciation of up to $24,000 in 2001 and 2002, and will increase to $25,000 for the year 2003 and beyond. While this is subject to several limitations, it is widely utilized by small farms to accelerate expense, if that is appropriate for your tax situation. Owners currently in high tax brackets that 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 Farmers 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. Ordinary income is currently taxed at a maximum rate of up to 39.6 % and long-term capital gains are taxed at rates of up to 20 percent. The sale of breeding stock qualifies for capital gains treatment (except that portion of the gain which is subject to depreciation recapture rules). Any alpacas held for resale, such as newborn cria that you do not intend to use in your breeding program, would be classified as inventory and produce ordinary income on sale.

The capital gains treatment of sale proceeds has become an even more attractive benefit of investing in alpaca breeding stock due to the 1997 Tax Act reduction in the capital gains tax rate to a top rate of 20% (from 28%) for assets held long-term (over 12 months). It also created a new 10% capital gains tax rate for taxpayers in the 15% ordinary income tax bracket. The tax break provides a slightly lower maximum rate (18%) in future years for investments held at least 5 years
.

There are other tax-saving strategies that can be utilized in concert with investing in alpacas. For instance, you generally can deduct the fair market value of a capital asset that 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 owner who wanted to diversify his blood-stock. 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 no 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 that 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 that 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.

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 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. On occasion, you may find a silver lining in the clouds of government
.


 

Alpaca Supply and Demand

The developing market for alpacas has been restricted by lack of supply. There are over 100,000 alpacas in America and about the same number in Australia. Until the last five years, there has been little aggressive marketing of the animal, very few auctions, and very little national media attention for the alpaca. Yet both North America and Australia have experienced exceptional demand for alpacas at very high prices. Canada has an active alpaca market, and many Canadians have recently purchased animals in the United States.

Supply will continue to be restricted in the near future for a number of reasons:

  • Alpacas reproduce slowly.
  • Many breeders retain their offspring, building their herds.
  • Mass production of "crias," or babies, via embryo transplant or artificial insemination is not feasible, since the technology for these procedures has not yet been successfully adapted to alpacas.
  • The limited size of the national herds in each country outside of South America will restrain growth for some time to come.
  • The U.S. alpaca registry is closed to further importation to protect our national herd, which will further limit U.S. herd growth.

Demand for alpacas has increased dramatically every year since their introduction outside of South America. The American and Australian breed associations each have over three thousand members, while only a few years ago there were none. Each association publishes a full color Alpacas magazine which is available to its members.

Not only are there more breeders entering the alpaca market each year in established countries such as Canada, New Zealand, Australia, and the U.S., but there are more countries competing worldwide to establish alpaca herds. Japan, Britain, Israel and France now have alpacas. This growth is sure to continue as the alpaca gains international recognition.

The demand for alpacas is part of a larger appetite for investment in rare breeds. Whole industries have sprung up around ostriches, miniature donkeys and even Tibetan yaks. Investment in rare livestock coincides with people’s desire to live in the country, raise their children on a farm, or retire to a rural lifestyle.

Alpacas offer an outstanding choice as a livestock investment. They have long been known as the aristocrat of all farm animals. But most of all, alpacas are easy keepers, they have a charismatic manner, they do very well on small acreage, and they produce a luxury product which is in high demand. Consumers are drawn to alpaca sweaters with just one touch. Alpaca is several times stronger and much warmer than sheep’s wool. The fiber itself is semi-hollow and makes very light, thermal garments. Alpaca fleece is easy to process and readily spins into both woolen and worsted yarn. Fabrics made from alpaca are sewn into the finest European suits and jackets.

Historically, alpaca production has been concentrated in the high Andes Mountains where pasture is limited. The worldwide population of alpaca is barely three million animals. As a result, alpaca is considered a specialty fiber with limited available supply. Alpaca fleece is comparable to cashmere in softness and is often mixed with other fibers, such as mohair, to vary the texture of the yarn produced. A strong domestic commercial market for large volumes of alpaca fleece is easily envisioned and a national fiber co-op is working with breeders large and small to see this vision become reality.

The potential market for an animal with the characteristics of the alpaca is vast. Alpacas are loved by their owners and respected by those who process or wear products made from their fleece. They are truly the world’s finest livestock investment.


   

Investing In Alpacas

An alpaca rancher with a small herd on a small acreage can expect to harvest his animals’ fleeces and sell their offspring profitably. The value of alpaca fleece is the economic underpinning of the future market for alpacas. Breeders outside of South America are beginning to organize wool co-ops for the commercial processing of the fleece. Domestic fiber is often sold to cottage industries that revolve around handspinning and weaving. Most alpaca ranchers readily sell their fleece for $2 to $6 an ounce to local artisans. Each animal will produce five to ten pounds of fleece a year. A North American fiber co-op, endorsed by the Alpaca Owners and Breeders Association (AOBA), provides a commercial outlet for all .

The current alpaca industry is based on the sale of quality breeding stock, which demands premium prices. Female alpacas begin breeding at between 14 and 18 months of age, while males begin breeding at between two and three years of age. The females produce one baby per year during a reproductive life of 15-20 years.

The factors which influence individual alpaca prices include color, conformation, fleece quality and quantity, age, and sex. Females sell for more money on average than males, but herdsire quality males demand the highest individual prices. Breeders often prefer one alpaca color to another, however; the parents color does not necessarily guarantee a cria of the same color. Correct, well-conformed alpacas sell for higher prices. Fleece density, uniformity, character and fineness also affect the animal’s price.

The range of value for females is currently between $12,500 and $40,000. Females with unique attributes have sold for more than $40,000. Young, unproven high quality stud prospects routinely sell for between $7,500 and $25,000, and the highest quality males with unique characteristics or exceptional offspring on the ground have sold in excess of $100,000. Many breeders start with several breeding age females and perhaps one male. Other new breeders may elect to start with several young animals or a breeding pair. There is an approach suitable for your level of interest and financial position. The financial analysis found below incorporates animal prices that a buyer can expect to pay for good quality, sound breeding stock. Alpacas are much like diamonds. The market pays premium for flawless examples of the breed.


"Alpaca Compounding"

A major investment benefit of owning alpacas is based on the concept of compounding. Savings accounts earn interest, which if left in the account, adds to the principal. The increased principal earns additional interest, thereby compounding the investor’s return. Alpacas reproduce almost every year, and about one-half of their babies are females. When you retain the offspring in your herd, they begin producing babies. This is "Alpaca Compounding." Tax-deferred wealth building is another "Alpaca advantage." As your herd grows, you postpone paying income tax on its increasing value until such time as you begin selling the offspring.


Capital Requirements

Many breeders start investing in alpacas by purchasing several females and one male. Others wait to purchase a quality breeding male. Prices can vary substantially depending on color, conformation, fleece quality, fleece quantity, age and sex.

A small barn or shelter, built specially to house 15 to 20 alpacas might cost about $10,000 to $l5,000 if you contract for its construction. Fencing could add several thousand dollars to your budget. If you manage the herd yourself, you’ll require an inventory of halters, shears, toenail clippers, lead ropes and other miscellaneous gear. These items would probably add $500 to your initial costs. Insurance is another consideration at a cost of 3-3.5% of the value of the animals. A year’s supply of hay and grain/chow will be required based on your region’s seasonal grazing and the amount of pasture you have.

If a person were to begin raising alpacas at his or her own ranch, a typical start-up budget might look like this: Acquisition of one pregnant female and one young female $40,000
Insurance, one year $1,300
Equipment $500
Small barn and fences $12,000
One year’s feed $300
Veterinarian and miscellaneous reserve $900

TOTAL $55,000


Hands-On Alpaca Ownership
There are essentially two ways to own alpacas. The first approach is to simply purchase the animals and begin raising them. The second approach is to purchase the animals and place them in the care of an established breeder. This arrangement for care and boarding of an animal on behalf of another is known as agistment. Under this method you, as owner, would still make the important decisions about care, breeding, sales, etc.

This article focuses on the owner-raised scenario. Many breeders will work with you to develop an analysis designed for your particular situation; however, you are encouraged to independently develop your own financial analysis using professional support if necessary. Expenditures of funds listed in this and other articles on this website warrant a full assessment of risks and the buyer needs to establish a comfort level that this is the right investment for their lifestyle.

Analyzing the feasibility of alpaca ownership requires making a set of assumptions. Determining the costs associated with raising the animals and how much they might sell for in the future are the basic elements used in projecting a return on the investment. The assumptions listed here are estimates based on many breeders’ experiences.

The hands-on method of raising alpacas, as either a part or full time business, requires that the alpaca breeder own a small farm or acreage. The property would need to be properly fenced and have a small barn or shelter. Many new owners already have outbuildings suitable for alpacas. The alpaca owner is presumed to supply the day-to-day labor.

This analysis is easily adapted to any size herd, whatever your financial situation and lifestyle may support. Many new buyers start with a breeding pair or with two females (and purchase stud services). The financial returns are similar at different ownership levels, so don’t feel that you have to be a large farm to participate.

Two different financial analyses illustrate this point. The first analysis reflects a program designed around selling all offspring to provide the shortest payback period to recover the initial outlay. The second analysis blends the selling of offspring with an element of herd growth. Both approaches have been utilized successfully within the industry. You can examine each approach and determine which scenario is most appropriate for your situation.


Financial Observations

Flat Herdsize scenario

  • The average annual before-tax cashflow return on the original investment is 26% (27% in years 2-10). This is an impressive return, but remember to consider all the hard work your family puts into nurturing this investment, although most alpaca breeders delight in the fact that they are being paid so well to live the lifestyle of their choice.
  • The payback period, based on before-tax cashflow, is slightly over 4 years, with the original herd still intact.

Growth Herd scenario

  • Cashflow return %'s are fixed at 27% in the Flat Herdsize scenario. The cashflow return %'s in the Growth Herd scenario increase to 64% by year 10.
  • The 10-year cumulative cash flow is $93,000 higher than the flat herdsize scenario. Cash flows are lower in years 1-3 and higher in years 4-10. The payback period, based on before-tax cashflow, is 5 years, which is one year longer than the Flat Herd scenario. This is a result of foregoing short-term sales in favor of putting additional females in production.
  • 8 breeding females have been added to the herd, a value of $180,000 at the end of year 10, which is in addition to the overall cash flow benefit as compared to the Flat herdsize scenario.
  • Growing the herdsize is a tax-deferred method of wealth building.

Both Scenarios

  • There are opportunities to increase profits by boarding animals ($600 to $1,200 per animal per year depending on geographic area), or by standing a superior male at stud ($1,000 to $3,000 per stud service). Your willingness to board could be a huge marketing advantage as many prospective customers do not have the facilities in place for animal care.
  • 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 offsetting your ordinary income from other sources with expenses from your farming business. See Tax Consequences of Owning Alpacas section of this brochure.
  • The financial return using the agisted approach, should you elect to board your animals, is also very good, not often matched by other investments. There are breeders who would be happy to discuss agisting alpacas on behalf of prospective owners.
  • Quality, color, sex of offspring, and strength of the overall industry could influence results positively or negatively.
  • It is important that you make a purchase decision using assumptions that reflect your personal tax and financial situation, as well as your own assessment of the alpaca industry.


Major Assumptions of Both Scenarios

  • The sale price of a female offspring (of breeding age) you raise is equal to the original cost per female in your initial herd. Younger offspring that are not of breeding age sell for less than mature animals. In this analysis, five pregnant females were purchased for $22,500 each. There are two herdsire quality males included in your initial purchase at $15,000. The sale prices for the males you produce were assumed to average $5,000 each. This allows for the fact that all males produced and sold would not be of herdsire quality.
  • You insure the herd for full mortality. Smaller herds are often fully insured against all risk, with no deductible, for about 3.25 percent of value.
  • It is assumed that you would have $12,500 in start-up costs for such things as barns, fences and equipment.

These improvements should also add value to your real estate and could be depreciated for tax purposes.




Alpaca Price Sensitivity
It is always wise to consider both the upside and the downside of any potential investment. It is important to feel comfortable with a range of possible financial returns should your actual experience differ from your assumptions.

Adjusting the model to make a one-time change of price by 10% in years 2-10, we find that the return percentages change by approximately 3% each year for every 10% price change in sales prices. In other words, your average annual return will be 23% should there be a 10% price decline or 29% should there be a 10% price increase. This indicates that it would take a severe price erosion to seriously jeopardize your initial investment.

For the reasons delineated in the Supply and Demand article, it is felt that long-term price stability is likely. A gradual supply increase due to natural restrictions coupled with a bright demand future would suggest that the assumptions utilized in the analysis are achievable. Keep in mind that the assumptions are not theoretical; they are drawn from actual current experience from farms across the country.

It is always wise to consider both the upside and the downside of any potential investment. It is important to feel comfortable with a range of possible financial returns should your actual experience differ from your assumptions. Adjusting the model to make a one-time change of price by 10% in years 2-10, we find that the return percentages change by approximately 3% each year for every 10% price change in sales prices. In other words, your average annual return will be 23% should there be a 10% price decline or 29% should there be a 10% price increase. This indicates that it would take a severe price erosion to seriously jeopardize your initial investment. For the reasons delineated in the Supply and Demand article, it is felt that long-term price stability is likely. A gradual supply increase due to natural restrictions coupled with a bright demand future would suggest that the assumptions utilized in the analysis are achievable. Keep in mind that the assumptions are not theoretical; they are drawn from actual current experience from farms across the country.

It is always wise to consider both the upside and the downside of any potential investment. It is important to feel comfortable with a range of possible financial returns should your actual experience differ from your assumptions. Adjusting the model to make a one-time change of price by 10% in years 2-10, we find that the return percentages change by approximately 3% each year for every 10% price change in sales prices. In other words, your average annual return will be 23% should there be a 10% price decline or 29% should there be a 10% price increase. This indicates that it would take a severe price erosion to seriously jeopardize your initial investment. For the reasons delineated in the Supply and Demand article, it is felt that long-term price stability is likely. A gradual supply increase due to natural restrictions coupled with a bright demand future would suggest that the assumptions utilized in the analysis are achievable. Keep in mind that the assumptions are not theoretical; they are drawn from actual current experience from farms across the country.

 


Windy Ridge Alpaca Farm • 1552 Sanctuary Lane • Homedale, ID 83628                     
208-571-6738 • e-mail: windyridgealpacas@gmail.com

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