FARMERS TAX GUIDE
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 or at the IRS website at http://www.irs.gov/pub/irs-pdf/p225.pdf. It is very informative.
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:
- 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
Then the following expenses may be deducted from this income:
- Vehicle mileage at .55 cents a mile for all farm business miles
- 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)
- Repairs and maintenance
- Interest
- Breeding fees
- Fertilizer
- Taxes and insurance
- Rent and lease costs
- Depreciation on animals used for breeding, real property improvements, barns and equipment
- Farm-related travel expenses
- Educational expenses, which improve your farming expertise
- Advertising
- Attorney fees
- Farm fuel and oil
- Farm publications
- AOBA dues and registry fees
- Miscellaneous chemicals i.e. weed killer
- Vet care
- Small tools having a useful life of less then one year
Please note: Personal and business expenses must be allocated between farm use and personal use, for instance, with such expenses as utilities, property taxes, accounting, etc. Only the farm use portion can be expensed.
AT RISK RULES
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 five years and forward for twenty 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
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 SIX YEAR WRITE-OFF
There are several methods of writing alpacas 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 a prorated write off based on the month of your purchase. The net result of this method is that it takes six years to write off your alpacas. The straight line system can only be used by making an election. There is also the modified accelerated cost recovery system using 150% declining balance and the half-year or mid-quarter convention (MACRS) which allows animals to be written off as follows: 15% year one, 25.5% year two, 17.85% year three, 16.66% years four and five, and 8.33% year six. This is an accelerated schedule allowing for a larger percentage of the asset to be written off early. The MACRS system is the system preferred by the IRS since it does not require an election. Alpacas born at your ranch have no cost basis and cannot be written off, although they may qualify for capital gain treatment on sale. The costs related to financing or interest on your purchase is also deductible. Many people pay cash for their animals so writing off the interest is not an issue. The following example articulates the benefits of tax deductions, both Section 179 and 2009 Special Bonus Depreciation, derived from an investment in alpacas. The examples do not include expenses for feed, veterinarian care, supplies, and transportation.