Alpacas – The World’s Finest Livestock Investment

Business or Investment?

If you are interested in alpacas, you must first decide how you would like to participate. Various degrees of involvement are possible, anything from active or "hands-on" engagement in the business to passive involvement purely for investment purposes. There are also people who own alpacas as pets or as a source of fiber to make and sell products. Raising alpacas as a business in most cases requires investment in fixed assets such as land, barns, fencing, etc. It also involves labor such as feeding and caring for the animals and farm maintenance. The investment side can be as simple as owning a stock or certificate of deposit, albeit with a better return and compounding. Indeed, many people discover alpacas as an alternative to traditional investments as a result of their disenchantment with those investments. To better understand alpacas as a business we need to look at the following issues: 1) the market for alpacas; 2) the characteristics of the investment, including risks, and 3) tax aspects of alpaca ownership.

The Market

Two organizations play a critical role in the market for alpacas: The Alpaca Owners and Breeders Association (AOBA) and The Alpaca Registry (ARI). These two organizations work in tandem to support alpaca breeders. AOBA disseminates information about alpacas to prospective entrants to the business through various media including television advertisements. They also sanction alpaca shows and determine the rules. The ARI tracks and insures the identity of the North American herd using DNA analysis. Only animals born of two registered parents may be registered. The existence of a closed registry for alpacas essentially means that new imports of alpacas cannot take place since they would not be registered. Imports from South America have been opened periodically at the behest of the breeders to improve and diversify bloodlines. The market impact of AOBA and ARI has been to keep prices firm for alpacas as a result of supply and demand and selectivity.

According to the last ARI census there were approximately 100,000 alpacas registered in the United States. This is a small number in comparison to the approximately three (3) million alpacas in Peru, Bolivia and Chile. Barring new imports, the slow reproduction rate of alpacas virtually guarantees slow growth of the herd. If we consider this information in conjunction with the strong demand for better herd quality in the U.S. and Canada, it is understandable why prices are so high and are likely to remain so for some years to come. The market, at this early stage in the cycle, is for animals, as opposed to the ultimate economic purpose of alpacas, their fiber. It is difficult to know what population of alpacas constitutes a critical mass for a fiber industry. What we do know is that this number is in the future and that it is likely to be a growing market for some years to come.

The market for alpacas has remained firm since their introduction to North America in 1984. Auction prices for bred females have been in the low to mid 20s in thousands; exceptional animals can sell for upwards of $30,000. Pet quality males can sell for as little as $1000 while a top herd sire set the record this year at $600,000. Stud fees range from $1500 to $7500.

Investment Characteristics

The following characteristics deserve consideration regarding alpacas as an investment: alternative status, insurability, guarantees, security, high yield, time value and liquidity.

The alternative status of alpacas as an investment is due to their exotic nature or perhaps more so, to our ignorance of their attributes and economic purpose. Livestock investing is considered exotic enough, but mention alpacas and people will see you either as crazy or a genius. Fortunately, familiarity makes alpacas appealing even to the most conservative investors. Yes, there are orphans and widows who own alpacas!

Full mortality insurance is available at a reasonable cost. Fertility and reproductive guarantees are standard trade practice. The ARI certificate guarantees the lineage of an alpaca using DNA analysis and serves as a title document establishing ownership and enabling the financing of animal purchases.

Alpacas as an investment have great return potential due to compounding. This means that the purchase of a bred female will provide a return with the birth of her cria, especially a female cria. Occasionally, males with herdsire potential may provide a windfall. Males without breeding prospects (destined to be gelded as pets or companions) provide a lesser return. There is also the possibility of a lost pregnancy or other setback. What is lost is time, so the time value of money is a consideration for alpacas as an investment.

Finally, there is the liquidity issue, or rather, the relatively illiquid nature of alpacas as an investment. Alpacas do not sell themselves; they require intensive marketing and promotional efforts. Treating them purely as an investment requires that the marketing issue be addressed with the breeder, i.e., how will the dividends (crias) be turned to cash? Fortunately, the proliferation of auctions, live and online, have provided an outlet and have made alpaca ownership more liquid and prices more transparent.

In summary, alpacas represent a safe and secure alternative to traditional investments with great potential returns and compelling prospects for establishing an income stream and building wealth.

Tax Consequences of Owning Alpacas

Raising alpacas at your own ranch, in the hands-on fashion, can offer 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 not only feed, fertilizer, veterinarian care, etc., but 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 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 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 C.D. could not be depreciated, thereby offsetting the 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 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 calculations:

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.

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 passive owner's losses which 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 IRIS 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 which 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. 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. It is often used by owners that are currently in high tax brackets that are changing their lifestyle in the next several years to a lower income level.

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, 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 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 31 percent and capital gains are taxed at rates of up to 20 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 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. It also created a new 10% capital gains tax rate for taxpayers in the 15 % ordinary income tax bracket. The holding period to qualify for capital gains treatment lengthened to 18 months from 12 months. 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 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 an owner 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. 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 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 your animal.

This discussion of tax issues omits a number of rules which 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.

Copyright 1997 Alpaca Owners and Breeders Association, Inc.