Financial Aspects

Financial Aspects and Business Opportunities of Alpaca Ownership

Introduction

Across American and around the world people call alpacas “The world's finest livestock business" Alpacas share many of the same attributes of gold, real estate, oil and stocks – all of which are supposed to increase in value over time.  In spite of the global economic downturn alpacas are still in demand.  The fiber they produce has unique qualities and is used by designers in the fashion centers of New York, Tokyo, Paris and Milan to produce high-end garments.

Taking up alpaca breeding is relatively straightforward.  They are easy to transport, have a relatively long and trouble-free reproductive life span, and alpacas can be fully insured against loss.   Breeding alpacas offers an excellent opportunity to create a profitable business.  Along with the profits, alpaca breeding is treated as any other livestock business by the IRS including tax advantages and incentives that you may qualify for.

Traditionally, livestock breeding and ownership characterized someone of wealth and status in many cultures including our own early Western Expansion days.  Today in America, wealth as a result of livestock ownership is not as common, but opportunities do exist to create a profitable farm breeding and raising alpacas. Tending to a graceful herd of alpacas can be an exciting way to earn a source of revenue and live a rewarding lifestyle.

Beginning in 1984, Peru Chili and Bolivia began allowing exportation of alpacas and at the same time countries such as the U.S., Canada, Australia, New Zealand, England and many European countries allowed their importation.  This was the beginnings of each country’s foundation herd...  In more recent years even Japan and South Africa have begun to build their own national foundation herds. What makes this animal so desirable? The bottom line: alpacas can be both profitable and enjoyable. 

Who Buys Alpacas In America?

People come to alpaca breeding from all sorts of prior experiences and alpacas are becoming an important source of income for many people.  Alpaca breeding is a very scalable business.  We are part-time alpaca breeders even though we have more than 75 animals on the farm; while others may be able to create a full-time business by raising far fewer animals.  The circumstances and situations people bring to the alpaca industry are varied:  couples with young children, retired couples, and everyone in between can find their own, comfortable level of engagement.  Fiber artists and hand-spinners have become alpaca owners as well as practicing veterinarians.  While most alpaca owners and breeders have an acre or two or more in the suburbs or country there are a growing number of owners who board or ‘agist’ their small herds on a nearby farm while they maintain their city lifestyle.  For everyone who enters the alpaca business, these beautiful animals allow you to diversify your income stream with a commodity that is functional, rare and entertaining all at the same time.

 Our farm of 75 plus alpacas and over 40 acres puts us in the large end of the range of all alpacas breeders though there are a few with over 500 alpacas and the largest, Magical Farms in Ohio, with more than 1,500 alpacas.  There are many alpaca farms with only two or three alpacas though the national average falls into the ten to 20 alpaca range.  Most herds start out small and grow to the size that fits the breeder's farm and financial goals.

We, like most alpaca breeders, are in business for the long haul.  In spite of the current economic downturn we 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 business opportunities. We encourage you to talk to breeders to familiarize yourself with the risks as well as the rewards of alpaca ownership.

Alpaca Supply and Demand

The market for alpacas has been moderated by the effects of relatively slow herd growth. As of early 2009, the total population of registered alpacas in North America is over 151,377 as reported by the Alpaca Registry, Inc.

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

·         Alpacas reproduce slowly. 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.

·         The limited size of the national herds in each country outside of South America will restrain growth to a small degree.

·         The U.S. alpaca registry is closed to further importation to protect our national herd, which will further moderate U.S. herd growth.

Meanwhile, demand for alpacas and their fiber has increased dramatically every year since their introduction outside of South America in1984. Because alpacas can be raised on such small acreage and in numbers there has been continual growth in the numbers of breeders entering the alpaca market each year here in the US.  This parallels the experiences in other countries with alpaca herds such as Canada, New Zealand and Australia.  And, this is in addition to the countries that are just beginning to establish their national herds. This growth is sure to continue as the alpaca gains international recognition.

Alpacas offer an outstanding business opportunity for livestock ownership. They have long been known as the aristocrat of all farm 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.

Alpaca Values

Based on our experience we believe that an alpaca breeder 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. Here in the US, our fiber is often sold to cottage industries that revolve around hand spinning, weaving and knitting. Our animals produce around five to thirteen pounds of fleece a year. Alpaca breeders can sell their fleece in a variety of ways including raw fiber, washed and carded fiber, yarns, and finished products, with lucrative margins. Profits or fiber production vary based on each farm's model for fiber sales.  At Sugarloaf Alpaca Company we are building a business model of vertical integration that will eventually bring in-house all steps in the fiber process from raising and shearing the animal to washing, and processing the fiber to creation of end products.  

The current alpaca industry is based on the sale 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 10-16 years based on our breeding experience.

Factors that influence individual alpaca prices include color, conformation, fleece quality and quantity, age, gender and heritage or lineage. 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.

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 a beauty is also in the eye of the beholder.

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. 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 limitations, and time constraints.

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.

Capital Requirements

Depending on your existing conditions you may find that you have only a small investment to make to facilitate breeding alpacas on your property.  If you start as we did, with a corn field, you’ll find prices for shelter, fencing and labor vary widely based on your location, as well as your 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 farm, a typical start-up budget might look like this (prices estimated based on typical costs in the U.S.A.):

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.  At Sugarloaf Alpaca Company we work with clients in both ways.

This discussion will focus on the owner-raised scenario. We 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. You need to establish a comfort level that this is the right balance for your 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 your 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 you eventually own a small farm 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 farm to participate.

Financial Observations

• 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 expenses from your farming business. (See Tax Consequences of Owning Alpacas)
• The financial return using the agisted approach, should you elect to board your animals, is also very good. We would be happy to discuss agisting your alpacas here at Sugarloaf Alpaca Company.
• Quality, color, gender of offspring, and strength of the overall industry could influence results positively or negatively.
• It is important that you make a purchase decision using assumptions that reflect your personal tax and financial situation, as well as your own assessment of the alpaca industry.
• We offer financing terms that can ease your entry into the alpaca business.  Payment terms vary.  Please ask us how we can help.

It is always wise to consider both the upside and the downside of any potential purchase, it is important to feel comfortable with a range of possible financial returns if your actual experiences differ from your assumptions.

Tax Consequences of Owning Alpacas

If you are considering entering the alpaca industry you 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 farm, in the hands-on fashion, can offer you some very attractive tax advantages, It 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 alpaca breeder and a passive owner involves the passive owner's ability to deduct losses against other income. If you are a passive investor may only be able to deduct losses from investment against gain from the sale of animals and fleece. The active breeder can take the losses against other income.

Alpaca breeding allows for tax-deferred wealth building. You 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 an alpaca breeder, you must establish that you are in business to make a profit and you are actively involved in you business. You cannot raise alpacas as a hobby farmer or passive investor and receive the same tax benefits 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 operate your farm in a businesslike manner.

·         The time and effort you spend on farming indicates you intend to make it profitable.

·         You depend on income from farming for your livelihood.

·         Your losses are due to circumstances beyond your control or are normal in the start-up phase of farming.

·         You change your methods of operation in an attempt to improve profitability.

·         You make a profit from farming in some years and how much profit you make.

·         You or your advisors have the knowledge needed to carry on the farming activity as a successful business.

·         You made a profit in similar activities in the past.

·         You are not carrying on the farming 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 raising 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 farmer'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 farm business (IRS publishes current rate)

·         Fees for the preparation of your income tax return farm schedule

·         Livestock feed

·         Labor hired to run and maintain your farm

·         Farm 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

·         Farm or investment-related travel expenses

·         Educational expenses, which improve your farming or investment expertise

·         Advertising

·         Attorney fees

·         Farm fuel and oil

·         Farm publications

·         AOBA (breed association) dues

·         Miscellaneous chemicals, i.e., weed killer

·         Veterinarian care

·         Small tools

·         Agistment fees

Please note: For hands-on breeders, 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 a telephone, utilities, property taxes, accounting, etc.

Once active alpaca breeders 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 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, 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 cash 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 farm 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 farmers 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 are the same as any livestock business and 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 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.

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:

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

Creating your 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 of late term pregnancy females. In this scenario you would buy a number of pregnant females who would deliver a cash crop of crias within a few months. 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 farm 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.

Alpaca Purchase Contracts

We prepare a written contract for every alpaca and breeding we sell. When purchasing an alpaca our contracts allow you to have a veterinarian exam certifying the alpaca's health at the time of purchase. Other clauses warrant that if you are purchasing a breeding male he will, in fact, settle females and that he is not sterile as a condition of birth. A contract for purchase of female alpaca will warrant that she is anatomically complete and capable of producing live offspring.  If you are purchasing a pregnant female or a breeding to one of our studs we will guarantee a live birth of the cria.

Our contracts 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. Like us, 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 the information presented here 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.

The preceding information was edited from the Alpaca Owners and Breeder’s Association website.