Let's consider what would happen if you purchased a herd of alpacas and put it into service in 2009) for $350,000. In this scenario we will assume you are in the 45% overall tax bracket (state and federal), use both the section 179 deduction and 50% bonus depreciation in year one, use the MACRS depreciation method, provide a $100,000 down payment, finance the balance at 8% interest for four years, and insure the investment for full value. All alpaca breeding stock and capital equipment acquisitions of up to $250,000 are 100% expensible in the year of purchase. Fifty percent bonus depreciation is applied to qualifying assets in excess of $250,000 (Please consult your accountant to determine how these benefits pertain to your actual taxable circumstances.)
FIVE YEAR AFTER TAX PURCHASE PROJECTION
(See PDF document to view entire Tax Planning table)
The total after tax cost of purchasing a $350,000 herd for taxpayers in the 45% bracket (state and federal) is $253,663, spread over six years, including principal, interest, and insurance.
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 lives. 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. A barn or special purpose agricultural building can be written off pursuant to Section 179 in the year it is put in service. If you do not chose to write the barn off as a Section 179 asset then you can depreciate it. To qualify for a 179 deduction it must be put in service after May 5, 2003 and before 2011. (Note: Section 179 will continue for years to come... the limitation changes though. For example: $250,000 for 2009, $125,000 adjusted for inflation in 2010 and back to $25,000 in 20100... as the law is written today.)
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 I've mentioned explains them well.
CAPITAL GAINS VS. ORDINARY INCOME
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. This year ordinary income will be taxed at a maximum rate of, up to, 35% and capital gains are taxed at rates of, up to, 15%. Previously these rates were 39% and 20% respectively. 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. Animals born on your ranch and held for breeding purposes, which usually involves holding them for more than two years, can be taxed at capital gain rates on sale. The capital gains treatment of sale proceeds are an attractive benefit of raising alpaca breeding stock.