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Financial Aspects of Alpaca Ownership Article

The Alpaca is a remarkable breed. Originating in South America, specifically in Bolivia, Chile and Peru, these animals are rapidly gaining in popularity throughout the world as a livestock breeding animal. Frequently referred to as, "The World's Finest Livestock Investment," alpacas are raised for their wonderful fleece. Currently there are approximately 90,000 alpacas in the United States and the demand for them has increased dramatically every year since their arrival in 1984 from South America. Due to the strong interest in alpacas and the limited number available outside of South America, there currently exists an excellent breeding market opportunity in the United States.

Below are excerpts from the AOBA 1999 Breeder's Guide article: Financial Aspects of Alpaca Ownership. Should you wish to learn more about the Alpaca I encourage you to contact me at Mail@AtlasAlpacas.com.

Introduction

Why do people in so many countries call alpacas, “The world’s finest livestock investment?” For any investment to be valuable, it must possess certain qualities which make it desirable. Gold is scarce, real estate provides shelter, oil produces energy, bonds earn interest, and stocks are supposed to increase in value, and diamonds symbolize love. Alpacas share many of these investment attributes.

Around the world, alpacas are in strong demand, and people pay high prices for them. They are scarce, unique, and the textiles produced from their fiber are known in the fashion centers of Paris, Milan and Tokyo. There are excellent profit opportunities and tax advantages available to alpaca breeders.

Since 1984, alpacas have appeared, almost simultaneously, in several countries where they had never been seen before. The U.S., Canada, New Zealand, France, Australia and England have all acquired the foundation animals for national herds. What makes this animal so desirable? Bottom line: alpacas are both profitable and enjoyable.

Alpacas are easy to transport, which allows them to be traded across the country or around the world. They have relatively long and trouble-free reproductive life spans and alpacas can be fully insured against loss.

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Who Buys Alpacas?

Alpaca breeders come from many walks of life. Increasingly, alpacas are becoming an important source of income for many people. Entire families are full-time alpaca breeders. Young couples with children might own three or four alpacas and enjoy caring for them. Retired couples, who have raised their kids, sold their business, and retired to the country, are often owners. The family whose members include a hand-spinner might own two or three animals for fiber production. Several breeders are veterinarians who have found the ownership of alpacas to be more rewarding than practicing veterinary medicine. Many herds are owned by families where one spouse works outside the home, and the alpaca business is managed by the other on their acreage in the suburbs or the country. A large number of breeders are working couples who tend to their herd in the evening after work. There are even city dwellers that have discovered the option of boarding (or "agisting") alpacas, thereby enabling city dwellers to maintain an alpaca operation while still retaining an urban career. For all owners, alpacas offer a great way to diversify their financial portfolio with a commodity that is both rare and in demand worldwide.

There are few large ranches with over 500 alpacas, small ranches of only two or three alpacas, and everything in between. The average alpaca herd consists of about ten to twenty alpacas. Most herds start out small and grow to the size that fits the breeder's ranch and financial goals.

Almost all breeders are in business for the long haul; they believe in the future of the industry. With the relatively small number of alpacas currently available, there will be an extended and steady demand for breeding stock to continue meeting the needs of our growing industry for many years.

It is important to recognize that alpaca ownership has inherent risks, as do all livestock and financial assets. You should talk to breeders to familiarize yourself with the risks as well as the rewards of alpaca ownership.

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Alpaca Supply and Demand

The market for alpacas has been moderated by the effects of relatively slow herd growth. As of early 2006, the total population of registered alpacas in the United States is estimated at 90,000.

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

  • The U.S. alpaca registry is closed to further importation to protect our national herd, which will further moderate U.S. herd growth.
  • Alpacas reproduce at a rate of 1 per year. A female generally breeds for the first time between 18-24 months of age, is pregnant for 11-12 months, and almost always only has one cria per year.
  • Many breeders retain their offspring to build their herds.

Meanwhile, demand for alpacas has increased dramatically every year since their introduction outside of South America (1984). 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 worldwide also actively establishing alpaca herds. This growth is sure to continue as the alpaca gains international recognition.

Alpacas offer an outstanding choice for livestock ownership. They have long been known as the aristocrat of all ranch animals. Most of all, alpacas have a charismatic manner, they do very well on small acreage, and they produce a luxury product which is high in demand.

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Alpaca Values

An alpaca owner 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 and finished products made from that fleece is the economic underpinning of the future market for alpacas. Breeders outside of South America are beginning to organize fiber co-ops for the commercial processing of the fleece. Domestic fiber is often sold to cottage industries that revolve around hand spinning and weaving. Each animal will produce around three to ten pounds of fleece a year. Alpaca ranchers sell their fleece in a variety of ways including raw fiber, washed and carded fiber, yarns, and finished products, with lucrative margins. Profits of fiber production vary based on each farm's model for fiber sales.

The current alpaca industry is based on the sale of quality breeding stock, which commands premium prices. Female alpacas usually begin breeding at between 15 months and 18 months of age, while most males can successfully impregnate (or "settle") a female at about three years. The females produce one baby per year (twins are uncommon) during a reproductive life about 15 - 20 years.

Factors that influence individual alpaca prices include color, conformation, fleece quality and quantity, age, and gender. Females sell for more money on average than males, but herd sire quality males have historically commanded 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. There are many accepted theories regarding alpaca color heritability, and more research is needed to further our understanding of this issue. Of more importance to most breeders is the overall physical soundness, or "conformation" of the animal. In addition to color, fleece, density, uniformity, fineness, luster and staple length will also affect value. Well-conformed alpacas with superior fleece characteristics sell for higher prices.

The range of value for females has remained fairly consistent during the two decades that alpacas have been available to the public in North America: generally between $12,000 and $40,000. Females with unique attributes have been known to sell for $50,000 or more. Proven, top-quality herd sires typically sell for $20,000-$50,000, and the highest quality males with unique characteristics or exceptional offspring on the ground have sold in excess of $150,000. Current record is in excess of $600,000.

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. Alpacas are much like diamonds. The market pays a premium for the finest examples of the breed, and beauty is also in the eye of the beholder.

Alpacas are also fully insurable against theft and mortality. Insurance can be purchased for your stock regardless of age. Average insurance rates are 3.25% of the value of the animal, or $325 for every $10,000 of insurance.

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Alpaca Compounding

Another benefit of owning alpacas relates to 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. Alpaca breeders also witness the effects of compounding over time. Alpacas reproduce almost every year, and about one-half of their babies are females. When you retain the off-spring in your herd, they begin producing babies. This is referred to as "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.

The graph above illustrates how a herd might grow in size over a ten year period, assuming you begin with five pregnant females and two males. The herd growth depicted represents alpaca compounding at work. The initial herd grows to 126 animals, assuming an 80% reproduction rate and a 50/50 male/female ratio. Not many investments appreciate at the same rate.

Please note that this graph, while clearly illustrating the principle of “alpaca compounding” does not depict the average owners’ approach to alpaca ownership. Most breeders elect to sell all or some of the annual offspring production for practical reasons, such as recovering their initial cash flow, acreage and building limitation, and time constraints.

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Creating a Herd

First, determine your goals for alpaca ownership. Would you like to own an inexpensive pair of gelding males for fiber production or as pets for you and your family? Are you going to be a full-time or part-time breeder? Will you invest in alpacas for current financial returns or are you going to build a herd toward the goal of being a full-time breeder? Once you've decided on your goal, the path to alpaca ownership will be more easily defined.

If you're interested in acquiring a producing alpaca herd with immediate sales, you may want to consider a larger initial outlay. You would probably buy a number of pregnant females who would deliver a cash crop of crias immediately. This larger expenditure might also encourage you to become more involved in the industry and spend more time marketing your herd. Some breeders with larger herds have full-time ranch managers or hire additional labor to assist them with the day-to-day chores. However you choose to be involved, there is an "Alpaca Approach" suitable for you. The industry is young and innovative strategies abound. Very few assets have the potential to reproduce themselves every year as an alpaca does. Today's smaller breeder can choose to be almost any size in the future. An owner, who likes the return alpacas offer, or the lifestyle they provide, can choose any level of ownership.

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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, typically would still make the important decisions about care, breeding, sales, etc.

This discussion will focus 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 utilizing professional support if necessary. Expenditure of funds warrants a full assessment of risks. The buyer needs to establish a comfort level that this is the right balance 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 found 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 ranch 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.

Many new buyers start with a breeding pair or 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 ranch to participate.

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Capital Requirements

Prices for shelter, fencing and labor vary widely based on geographic location, as well as individual needs and tastes. For example, some alpaca breeders will opt for a $500 carport structure as a shelter for their animals, whereas others might spend upwards of $100,000 or more for a state-of-the-art breeding facility and showplace. Additionally, 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 a consideration, and generally costs approximately 3.25% of the purchase price, paid each year in advance. If a person were to begin raising alpacas at his or her own ranch, a typical start-up budget might look like this (prices estimated based on typical costs in the U.S.):

Acquisition of two pregnant females
Insurance on animals, one year
Equipment
Small barn and fences
One year's feed
Veterinarian and miscellaneous reserve

TOTAL  

$ 35,000
$ 1,100
$ 500
$ 30,000
$ 300
$ 1,100

$ 68,000


[Costs are rough estimates for comparison purposes only. Actual costs may be higher or lower than figures depicted, depending on a wide variety of factors such as geographic location, available pasture, climactic conditions, health of animals, etc.]

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Methods of Financing Your Alpaca Purchase

Most alpacas are sold for cash. Many buyers convert other assets to purchase their first alpacas. Some people have a line of credit for investment purposes; others use their equity in real estate to secure funds. Some breeders offer financing for your purchase. It is typically short term and involves paying for the animals before you take delivery of them. For instance, many breeders will accept the following arrangement:

1. Purchase price
2. Down payment
3. Three installments of $4,500 each
4. Balance at delivery

$22,500
<-9,000>
<-13,500>
-0-

For a financed sale, a breeder may require that the purchaser obtain insurance for the animals with the seller listed as a co-insured party and insurance proceeds distributed first to pay the remainder of the lien.

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Alpaca Purchase Contracts

Every purchaser should require a written contract when acquiring an alpaca. A typical contract will call for a veterinarian exam certifying the alpaca's health at the time of purchase. Other clauses might warrant that a breeding male will, in fact, settle females and that he is not sterile as a condition of birth. A contract for purchase of female alpaca will often warrant that she is anatomically complete and capable of producing live offspring.

Contracts will specify the financial terms involved and include small details such as who delivers the animals. It is important to know what happens if there is a future problem with the alpaca that you purchase. For instance, a young male could grow up to be sterile. This condition may not be known for one or two years after purchase. Most breeders will agree to replace the animal if this happens.

Contracts are important so that all the elements of a purchase can be accounted for. It is also important to deal with a breeder of good reputation, one who will provide follow-up care. You are making a large purchase when you buy alpacas and it's important that you feel good about it.

Many alpaca owners who have been involved in the alpaca lifestyle have found it both personally and financially rewarding. Please recognize, however, that owning alpacas involves significant financial risks, as does any business start-up. Your ultimate success will be determined by your own ability to market your animals: your fiber and finished goods: your employment of available resources within the alpaca industry: your communication skills: and your ability and willingness to provide top-notch customer service that results in a good reputation. Although this article discusses techniques that many people have used to make alpaca breeding a profitable business venture, it is, of course, impossible to guarantee the ultimate success of any business.

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Tax Advantages of Owning Alpacas

Those considering entering the alpaca industry should engage an accountant for advice in setting up your books and determining the proper use of the concepts discusses in this brochure. A very helpful IRS publication, #225, entitled The Farmer's Tax Guide, can be obtained from your local IRS office. The goal of this discussion of IRS rules is to provide the guidelines for discussion with your accountants and financial advisors so that you can be more conversant in the issues of taxation as they relate to raising alpacas.

Raising alpacas at your own ranch, in the hands-on fashion, can offer the rancher 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 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 breeding stock and expense the direct cost of maintaining the animals. The main difference between a hands-on or active rancher and a passive owner involves the passive owner's ability to deduct losses against other income. The passive investor may only be able to deduct losses from investment against gain from the sale of animals and fleece. The active rancher can take the losses against other income.

Alpaca breeding allows for tax-deferred wealth building. An owner can purchase several alpacas and then allow the herd to grow over time without paying income tax on its increased size and value until he or she decides to sell an animal or sell the entire herd.

To qualify for the most favorable tax treatment as a rancher, you must establish that you are in business to make a profit and you are actively involved in your business. You cannot raise alpacas as a hobby rancher or passive investor and receive the same tax benefits as an active, hands-on, for-profit rancher. A ranching 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 ranch in a businesslike manner.
  • The time and effort you spend on ranching indicates you intend to make it profitable.
  • You depend on income from ranching for your livelihood.
  • Your losses are due to circumstances beyond your control or are normal in the start-up phase of ranching.
  • You change your methods of operation in an attempt to improve profitability.
  • You make a profit from ranching in some years and how much profit you make.
  • You or your advisors have the knowledge needed to carry on the ranching activity as a successful business.
  • You made a profit in similar activities in the past.
  • You are not carrying on the ranching 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 ranching 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 owner's and a full time rancher'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 ranch business (IRS publishes current rate)
  • Fees for the preparation of your income tax return ranch schedule
  • Livestock feed
  • Labor hired to run and maintain your ranch
  • Ranch repairs and maintenance
  • Interest
  • Breeding fees
  • Fertilizer
  • Taxes and insurance
  • Rent and lease costs
  • Depreciation on animals used for breeding
  • Depreciation of real property improvements such as barns and equipment
  • Ranch or investment-related travel expenses
  • Educational expenses, which improve your ranching or investment expertise
  • Advertising
  • Attorney fees
  • Ranch fuel and oil
  • Ranch publications
  • AOBA (breed association) dues
  • Miscellaneous chemicals, i.e., weed killer
  • Veterinarian care
  • Small tools
  • Agistment fees

Please note: For hands-on ranchers, personal and business expenses must be allocated between ranch use and personal use; only the ranch use portion can be expensed for such expenses as a telephone, utilities, property taxes, accounting, etc.

Once active alpaca ranchers 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

The passive owner's losses that 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 IRS code. Animals raised for sale are generally exempt from the uniform capitalization rules, and there are other exceptions for certain ranch 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, seven, or ten 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, trailer, 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 ranches to accelerate expense, if that is appropriate for your tax situation. Owners currently in high tax brackets who 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 Farmer's 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. 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 crias that you do not intend to use in your breeding program, would be classified as inventory and produce ordinary income on sale.

This discussion of tax issues omits a number of rules that could impact your taxes. Tax preference items, alternate minimum taxes, employment taxes, installment sales, additional depreciation, 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 the assistance of professional accounting and legal assistance.

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 off-setting your ordinary income from other sources with the expenses from your ranching 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.

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David Kabbai - 619.890.9297 - 1.877.611.1319