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Things to Consider - Part 2
This is a continuation of the “Things to Consider When Starting or Operating
an Alpaca Business” series.
The IRS nine-factor test is a list of things to keep in mind when making
business decisions. If you get audited, as we mentioned in Part One, the
most likely manner of the audit will be correspondence. The nine factors
almost always are brought up in the correspondence as questions about
The section on land use is intended to be a reminder of all the things you
should be informed about before you bring your first alpaca home. If you
relocate, these are things you should check into before you sign a purchase
The factors (called the 9 factor test) the IRS considers when determining
whether you are engaged in a business or a hobby are:
Manner of business. The IRS has asserted that tree farming, horse
breeding, and similar businesses were hobbies rather than businesses. At
one time, tax auditors were advised that alpacas were “exotic” animals and
raising them was not a mainstream livestock business. Many states have
specifically changed the status of alpacas and llamas to “livestock” and in a
footnote in a bill a few years ago, congress referred to alpacas as livestock.
This provides a basis for arguing that raising alpacas is a business.
Expertise of taxpayer. An agricultural background helps, of course, but
attending the many types of animal husbandry, genetics, fiber, business,
and other courses offered by AOA can be proof that the taxpayer is
acquiring the necessary expertise.
Time and effort involved. Most of us work very hard and long hours making
our business successful. Those who agist their animals must still materially
participate in taking care of the animals, making breeding and marketing
decisions, and even shoveling poop.
Expectation of assets appreciating. If we expect our alpacas to appreciate,
it looks like an investment rather than a business. On the other hand, we
would expect a breeding animal to appreciate if it wins show ribbons, has
winning offspring, and has superior EPD statistics. This is something that
must be carefully explained to an auditor or tax preparer.
Success in similar or dissimilar activities. Someone who was successful at
breeding dogs, for example, might be expected to be successful at breeding
alpacas, as some of the same skills would be used. Business success is
considered predictive of success in general, since no one, presumably,
would get involved in a business with the intention of losing money. On the
other hand, someone with a successful professional career might want to
offset some of his/her tax burden with an enjoyable business that
generates tax losses. These things have to be weighed.
History of income and losses. The IRS presumes that you are engaged in
business if you make a profit in two years out of every five. (But this merely
means in that event, you don’t have to prove to the IRS that you are in
business). Conducting your alpaca business in a businesslike manner can
also prove you are in business without necessarily showing a profit. What
matters is how the business is conducted. Business plans, P&L statements,
balance sheets—all play an important part.
Amount of occasional profits. There could be a problem if you never, ever
report any income. Even if you don’t make a profit, you should have some
income or you risk the appearance that you are not engaged in a business.
Financial status of taxpayer. On occasion, the IRS has challenged a
taxpayer who has a lot of income and a lucrative, full-time job as not being
in business. A tax court case a few years ago involved a lawyer with a full-
time law practice who was also a tree farmer. You may disagree that a
professional person cannot also be in the business of tree farming, but be
aware this kind of situation can invite scrutiny.
Elements of personal satisfaction or recreation involved. This ninth factor
hearkens back to the horse-breeding cases the IRS won in the 70s and 80s.
(A breeder whose kids are active in 4-H may need to watch out for this one.)
If you love to ride horses, the IRS reasons that you may be getting more
out of it than a person who is in business should be.
Recently, the Third U.S. Circuit Court of Appeals (which covers Pennsylvania,
New Jersey, and Delaware) gently ridiculed the recreational factor as
applied by the IRS to horse training, so there may be possible changes to
this factor in the future—but the remaining circuits have not weighed in on
this case yet, and may disagree. The IRS can disregard this case in all
circuits but the third.
Hobby losses: You can still deduct losses if you are engaged in a hobby, but
only to offset any money you earn. Most breeders with actively earned
income from another job or business want to offset some of that. Engaging
in the legitimate business activity of raising alpacas and producing products
from their fiber, with the intention of making a profit, is a good way to do
Some general comments about conservation easements: The tax code
allows people to deduct the value of conservation easements in many
places (adjacent to public land, for example). This is usually determined by
subtracting the “after easement” value of the land from the “before
easement” value. These are very tricky and require good legal and tax
advice to accomplish, but can be worthwhile as a way to reduce one’s tax
Part Three will address zoning, covenants, and some basic concepts of
* This article is not intended to provide legal or tax advice. You should
consult your own lawyer or tax adviser for advice specific to your own
|Things to Consider When Starting or Operating an Alpaca
Related Business - Part 2
A Three-Part Series from AOA GIRCom