One of the frustrating factors in dealing with the IRS rules is getting to a definitive answer. The code is often more grey, than black or white; consider the following statement which is found in IRS publication 225, Farmers Tax Guide:

"This publication covers some subjects on which a court may have made a decision more favorable to taxpayers than the interpretation of the Service. Until these differing interpretations are resolved by higher court decisions or in some other way, this publication will continue to present the interpretation of the Service."

I recommend everyone who farms alpacas obtain a copy of this handy guide at your local IRS office. It is very informative.

I must confess, I don't like to pay taxes; I always do, but I'm never happy about it. I inherited this bias, I believe, from my father. Dad, for those who don't know him, is always fully convinced of his beliefs, and he believes that IRS agents are the bad guys.

Dad was one of the first full time llama farmers in the U.S. to be audited by the IRS. It was quite a task to prove to the agent who conducted Dad's audit that llamas were in fact a profit making enterprise. The agent decided that before he completed his review of Dad's tax return, he wanted to see these llamas with his own eyes; just to make sure, of course, that everything was on the up and up.

After much negotiating between my dad's accountant and the agent, it was agreed that the agent could view the llamas from the road in front of Dad's farm; he wasn't to be allowed on the property. When the fateful day arrived, Sam, the IRS agent, appeared at the fence in front of Dad's ranch. It wasn't long before Bonnie, his big black llama, wandered up to the fence and offered Sam a kiss. I still to this day believe that my dad's audit is the only one ever closed as a result of a llama's kiss. Thank God, she didn't spit!

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. The discussion from here forward presumes you are a cash basis taxpayer and you keep good records. Accrual basis tax payers would also be allowed the same tax treatment, but their timing might be different.

First, the following items must be included in your gross income calculations:
• 1. Income from the sale of livestock
• 2. Income from sale of crops, i.e., fibre
• 3. Rents
• 4. Agriculture program payments
• 5. Income from cooperatives
• 6. Cancellation of debts
• 7. Income from other sources, such as services
• 8. Breeding fees

Then the following expenses may be deducted from this income:
• 1. Vehicle mileage at 28 cents a mile for all farm business miles
• 2. Fees for the preparation of your income tax return farm schedule
• 3. Livestock feed
• 4. Labor hired to run and maintain your farm (remember, you must not deduct the expense of maintaining your personal residence)
• 5. Repairs and maintenance
• 6. Interest
• 7. Breeding fees
• 8. Fertilizer
• 9. Taxes and insurance
• 10. Rent and lease costs
• 11. Depreciation on animals used for breeding, real property improvements such as barns and equipment
• 12. Farm-related travel expenses
• 13. Educational expenses, which improve your farming expertise
• 14. Advertising
• 15. Attorney fees
• 16. Farm fuel and oil
• 17. Farm publications
• 18. AOBA dues
• 19. Miscellaneous chemicals i.e. weed killer
• 20. Vet care
• 21. Small tools having a useful life of less then one year

Once you've determined your net income or loss, it is included on your tax return as an addition to or a deduction from your 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:
1. The amount of money you contribute to an activity
2. The amount you borrow for use in the activity

You must establish the cost basis of your 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 charge 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 which allow for a larger percentage of the asset to be written off early. Alpacas born at your ranch have no cost basis and cannot be written off, although they may qualify for capital gain treatment on sale.

Capital improvements to your ranch can also be written off against income. Barns, fences, pond construction, driveways, parking lots all 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 forty years.

The original cost bases 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 I've mentioned explains them well.

When an asset is sold, say for instance a female alpaca, which was purchased for breeding purposes and held for several years, the gain or loss must be determined for tax purposes. If this alpaca was purchased for $20,000 depreciated for two and a half years or, say, 50% 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 costs 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, 31 percent and capital gains are taxed at rates of, up to, 28 percent. 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 cria which you do not intend to use in your breeding program, would be inventory and produce ordinary income on sale. If the present administration is successful at raising the tax on ordinary income to 39 percent and capital gains remain taxable at 28 percent, the capital gains treatment of sale proceeds will become an attractive benefit of raising alpaca breeding stock.

There are other tax-saving strategies that can be utilized in concert with operating your farm. For instance, you are entitled to claim a charitable deduction for the fair market value of a capital asset, which 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 a breeder who wanted to diversify his bloodstock. 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. I'm sure your C.P.A. 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 which 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 the your animal.

Please bear in mind that I am not an accountant. This discussion of tax issues omits a number of rules which will impact your taxes. I did not discuss tax preference items, alternate minimum taxes, employment taxes and other concepts of importance. Whether we like it or not, this is a complicated world we live in; it often requires CPA's and on occasion an attorney. Whatever happened to the days when all you needed to farm was a mule, a plow, and a strong back.

In summary, the major tax advantages of conducting an alpaca business include the employment of depreciation, capital gains treatment, and the benefit of offsetting your ordinary income from other sources with losses 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.

In closing I wanted to let you know that the idea of taxes is not new nor an exclusive sin of the United States Government. Caesar Augustus decreed, in Roman times, "that all the world should be taxed," The politicians have taken taxation to heart for centuries. We have, on occasion though, been given good advice about our responsibility to pay tax. The Honorable Supreme Court Justice Learned Hand had the opportunity to instruct the IRS, in a high court decision, that it was not a citizen's duty to conduct himself so as to pay the maximum tax possible, but that a common man might arrange his affairs so as to pay the least amount of tax possible. God bless the judge, and God bless our alpacas!